Wall Street Strategists Are Ratified by Dow's Record (Update1)

By Eric Martin and Michael Patterson

Oct. 1 (Bloomberg) -- Wall Street strategists got it right when they predicted two months ago the U.S. housing slump wouldn't end the stock market's five-year rally.

The Dow Jones Industrial Average today climbed above 14,000 for the second time in its 111-year history to close at a record, recovering from a July and August sell-off that wiped out almost $2 trillion in U.S. market value. Alcoa Inc., the world's second- largest aluminum company, and General Motors Corp., the biggest U.S. automaker, led the rebound.

The gains were sparked by the Federal Reserve's decision Sept. 18 to lower its benchmark interest rate for the first time in four years. Strategists tracked by Bloomberg maintained their prediction that the Dow average would end the year at almost 14,200, even as the gauge plunged to a three-month low of 12,845.78 on Aug. 16.

``This correction was very short,'' said Kenneth Fisher, who oversees $42 billion at Fisher Investments in Woodside, California. ``To me, that's the surprising part. The reason forecasts haven't necessarily dropped so much is because it hasn't been that long.''

The Dow average, created in May 1896 by Dow Jones & Co. to measure the performance of industrial companies, climbed 1.4 percent to a record close of 14,087.55 in New York as investors speculated the worst may be over for banks and construction companies hurt by subprime mortgage losses.

Fed Rate Cut

None of the 13 the Wall Street strategists tracked by Bloomberg cut their 2007 Dow or S&P 500 forecasts through the sell-off, even as borrowing costs between banks surged to the highest in six years and defaults on home loans to people with poor or limited credit deepened the worst U.S. housing slump in 16 years.

Citi Investment Research, A.G. Edwards & Sons Inc., Goldman, Sachs & Co. and Strategas Research Partners LLC, the four firms that provide Bloomberg with year-end forecasts for the Dow, on average predict the gauge will climb to 14,162.5 this year.

U.S. stocks surged on Aug. 17 after the Fed unexpectedly reduced the interest rate it charges banks, the first time it has cut borrowing costs between scheduled meetings since 2001. Fed Chairman Ben S. Bernanke's reduction of the discount rate was his first acknowledgement that a policy shift was needed to contain the subprime-mortgage collapse.

Cheaper Stocks

Stocks rallied the most in four years on Sept. 18 after the Fed cut its benchmark lending rate by half a percentage point to 4.75 percent, more than economists surveyed by Bloomberg had expected.

The rebound has left the Dow average within 0.6 percent of strategists' average year-end forecasts. For the Standard & Poor's 500 Index, they are forecasting a year-end close of 1,595, the most bullish since December 2000, data compiled by Bloomberg show. They have become more optimistic during the year, bringing the average S&P 500 estimate up from 1,550 in January. The S&P 500 climbed 1.3 percent to 1547.04 today.

Both the Dow and the S&P 500 are cheaper now than when they reached records on July 19. The Dow trades for 17.1 times its members' profit in the past year, down from 18.6 in mid-July. The S&P 500's price-earnings ratio has dropped to 17.9 from 18.2, according to data compiled by Bloomberg.

Alcoa, GM

Alcoa has rallied 23 percent since Aug. 16 for the best gain in the Dow average. GM has climbed 17 percent. The Dow average has surged 93 percent since falling to a five-year low on Oct. 9, 2002.

Strategists such as Tobias Levkovich at Citi and Alfred Goldman of A.G. Edwards say that stronger economic growth outside the U.S. will mitigate any slowdown in America and boost earnings at the biggest companies with businesses that span the globe. Levkovich predicts the Dow average will end 2007 at 14,400, while Goldman has a year-end target of 14,500.

Overseas sales accounted for about 43 percent of the revenue reported by companies in the Dow average last year, according to data compiled by Bloomberg.

`There's Been Pain'

``In financials, housing, credit-related areas, there's been pain, but why should that impact a health-care stock?'' Levkovich, chief U.S. equity strategist at Citi in New York, said in an interview last month. ``Is anyone going to buy a single drug less because there's a subprime problem?''

A.G. Edwards's Goldman on July 17 raised his year-end forecasts for the Dow average and the S&P 500 to 14,500 and 1,650, respectively -- three days before the Dow began its plummet from its record. The forecasts proved to be prescient in part because of the Fed's rate cut.

``The sell-off the subprime losses caused was greater than I was cranking into my year-end projection,'' Goldman, the St. Louis-based chief market strategist at A.G. Edwards, said last month. Once in a while ``I'll be right on the number. You know why? Luck.''

Last Updated: October 1, 2007 18:40 EDT