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hiker

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published 10/10 by Standard & Poor's Equity Research -

Although we remain optimistic about the market this year, some potential problems concern us.

                                       

Judging by recent developments, some companies appear to be getting a bit cautious about their cash. The September quarter saw no year-over-year advance in the number of dividend increases, but a substantially higher number of dividend omissions.

Last month alone, there were 11 omissions among the 7,000 companies that report their dividend activities to Standard & Poor's. While 11 payments eliminated from such a large universe of companies might not seem like much, only one dividend was omitted in September 2004 and just two disappeared in September 2003. In fact, you have to go back to April 2002, when the economy was much weaker, to find 11 omissions.

It's much too early to say that recent dividend activity is ominous. Some companies may be husbanding cash because they are planning to increase capital spending or share buybacks. Other uses for cash could explain the lack of increases reported for the quarter.

More worrisome to us is the higher level of omissions. Once companies institute a dividend, we believe they try very hard to maintain it. Even though dividends are not an obligation of the corporation, most boards seem to act as if there were an implicit agreement to continue paying. So the omission of a dividend implies to many shareholders that the company's financial condition has deteriorated.

Speaking of deterioration, the technical condition of the market appears to have weakened, as the S&P 500 fell below the 1200 support level. According to Mark Arbeter, Standard & Poor's chief technical analyst, that completes a bearish "double top" reversal formation. Arbeter now sees the "500" testing further support at about 1155. He also notes recent weakness in energy and homebuilding stocks, two of the groups that have led the market higher over the past year.

October often sees reversals to the upside, and we still expect the market to finish 2005 higher. But our optimism is of the cautious variety.




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hiker

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index of the most sensitive housing stocks, updated 10/10 -

http://www.investech.com/

Housing Bubble Bellwether Index is now down 23.4% from its July high .....

---------------------

Presidential panel recommends decreasing the allowable mortgage interest deduction to be limited to interest on mortgage indebtedness of $350,000 for a couple filing jointly vs. the present $1 million indebtedness limit:

http://www.washingtonpost.com/wp-dyn/content/article/2005/10/11/AR2005101101549.html

------------------

Wednesday, 10/12 -

13:19 Sector Watch: Homebuilders finding interest in recent action

While the HGX 484.45 -0.7%% is still in the red, several issues in the sector have seen intraday buying interest develop (LEN -0.8%, BZH +0.8%, KBH +0.4%, RYL +0.3%, MTH -1.4%, HOV -0.7%, SPF -0.3%).

11:05 Fed Tracker:

Gov Bies speaking on banking regulations pointing out that regulators are "carefully monitoring" commercial lending and the banking standards are under "downward pressure". She will not be speaking on the economy or interest rates.



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Friday, 10/14 -

30-year fixed mortgage interest rate above 6% for the first time since March '05...this may not be the national average, but was reported tonight on local news.


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published 10/17 by S&P equity research -

Will the bull continue to charge into its fourth year? Earnings being reported now may hold the key.

                                       

It's been a little more than three years since the S&P 500's worst bear market in a generation bottomed on October 9, 2002. By modern stock market standards, the bull move that started the next day is getting a bit old.

Since 1942, the average bull market (defined as an advance of at least 20% from the low in the previous bear market) has lasted 56 months, according to Sam Stovall, Standard & Poor's chief investment strategist. But averages can conceal a wide range of outcomes: The length of bull markets has ranged from 26 months to 113 months.

Of the 10 bulls that preceded the current one, six lasted at least four years. Those long-lasting bulls posted an average gain of 14% in their fourth year. We don't yet know if this bull ended with a peak in early August, or if it is, in fact, charging into its fourth year.

Whatever the case, we believe that stocks are facing headwinds, including higher energy prices and interest rates. Even though energy prices have eased a bit, government estimates are that natural gas heating bills will surge 48% this winter, while oil heat will cost 32% more. And that's with a forecast of a fairly mild winter.

High energy costs and word that August saw the biggest increase in prices paid for imported goods in 15 years will add to pressure on the Fed to keep inflation in line. Even though the core CPI (excluding food and energy) rose only 0.1% in September, we expect no pause in the upward march of the fed funds rate, which we see at 4.5% as Alan Greenspan's term as chairman ends in January.

At the start of the current earnings season, our analysts were expecting a 15% year-over-year gain in third-quarter operating profits for the S&P 500. That's close to the 17% gain posted in the same period of 2004.

A better showing might be enough to breathe life into this bull.




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hiker

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Tuesday, 10/18 -

10:42  Housing index -HGX- breaks down to new sesison low, approaching the 5 month low from last wk at 471.17-- session low 472.32 (472.78 -16.12) -Technical-

Issues under pressure include: HOV -4.3%, CTX -3%, LEN -3.3%, PHM -5.2%, KBH -3.9%, RYL -3.6%, BZH -3.3%.  


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hiker

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Wednesday, 10/19 -

Meanwhile, Treasuries have risen for the second straight session. In a speech after the market's close yesterday, Federal Reserve Vice Chairman Roger Ferguson indicated that higher energy costs will slow the economy.  Specifically, Ferguson said he expected high oil prices would be "quite long lasting'' and shave 1%  from growth this year and another 0.5% in 2006. His comments came after Fed Chairman Greenspan said in a speech that "although the global economic expansion appears to have been on a reasonably firm path through the summer months, the recent surge in energy prices will undoubtedly be a drag from now on.'' Following the latest Fed-speak, bond traders appear to have breathed a slight sigh of relief with respect to concerns and uncertainty over the Fed's tightening policy. .

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mortiz

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Steve,

 

With respect to the S&P Equity Research report contemplating the market performance in 2006, Tom McClellan presented a very interesting hypothesis on the topic (in the latest twice-monthly McClellan Market Report) of the widely expected 4 year cycle bottom in 2006.  In a sense, Tom's missive ties in with the S&P report.

 

Of course I cannot post excerpts from Tom's study, but he employed some of his unique market "time" analogies comparing the second year of an incumbent Republican president's second term with respect to stock market bottoms.

 

The gist of Tom's report concludes the limited sampling history of market performance in the 2nd year of the 2nd term of an incumbent Republican president, has resulted in a down market only once....  during Nixon's 2nd term in 1974, which of course, was also a year where Nixon resigned, the Vietnam war came to unfavorable (for the U.S.) end, and the Arab oil embargo took place.

 

The strongest analogies of the 2nd year/term for a GOP president was in 1986 (Reagan) and 1958 (Eisenhower).  In both cases, 4-year cycle lows were expected, but didn't transpire, with the bottoms deferred for a year or so.  Currently, there is a strong analogy correlation between the current SPX price pattern and the SPX pattern of 1985-86 which makes Tom's hypothesis even more interesting for the notion the next 4-year cycle bottom may be late.

 

The downside to the 4-year cycle bottom being a year late, are the ugly declines that ultimately led to price bottoms in 1959 and 1987.  Tom's point was not to argue for the certainty of an up year in 2006, but present an argument against the certainty of a 4-year cycle decline transpiring in 2006.

 

To fully digest Tom's interesting theory, one needs to read the article.  And by the way, for those who are interested in unique approaches of looking at stock, bond, gold and other commodity markets, I highly recommend, at a minimum, subscribing to Tom & Sherman's twice monthly publication.  For $195 per year, one learns a lot about a lot of topics. 

 

Randy

 

 

 

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hiker

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Market Insight, published 10/24 by S&P Equity Research -

We now see the S&P 500 ending this year not much higher than where it began 2005. Next year, we expect only modest gains.

                                       

In the face of rising interest rates, persistently high energy prices that could restrain consumer spending, and several downbeat corporate revenue forecasts, Standard & Poor's Investment Policy Committee has lowered its stock market expectations for this year and next. We now see the S&P 500 ending 2005 at 1220 (previously we had predicted 1270) and 2006 at 1290 (formerly 1335).

Because of the lower targets, we have reduced our recommended domestic equities exposure to 45% from 50% and increased our foreign stock allocation to 20% from 15%. To effect these changes in our model exchange-traded fund portfolio, we suggest that you reduce your holdings in the S&P 500 to 35% (from 38%), the S&P MidCap 400 to 6% (from 7%), and the SmallCap 600 to 4% (from 5%). We advise increasing exposure to emerging markets to 3% (from 2%) and adding a 4% position in Japan (via the iShares MSCI Japan ETF; ticker EWJ).

This year has been a disappointment for investors, with the S&P 500 now below where it started 2005. We still expect a rally in the traditionally strong fourth quarter, and do not suggest that you abandon equities.

The advance we anticipate should cause the market to end the year with a gain of less than 1%. If that expectation and our projection of a 5.7% advance in 2006 prove true, few investors will be delirious with excitement over the next 14 months.

That's why we suggest that investors now tilt their portfolios to overweight stocks in the consumer staples and health care sectors. Demand for the goods and services provided by companies in these sectors tends to be relatively stable, no matter the economic conditions. In other words, if the cost of heating their homes and driving to work leaves people with fewer dollars to spend, necessities like food and medicine probably will take precedence over the purchase of new gadgets.




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Wednesday, 10/26 -

12:10  Snow out offering advice on deficits, saying they are bad

Treasury's Snow on the stump saying deficits "should be avoided," can slow economic growth and tweak interest rates higher (for those unaware).

08:10 Mortgage Applications

The weekly MBA mortgage applications index dropped -7.9% last week, with purchasing applications dropping -7.4%, and refinancing falling -8.5%. The fixed 30-yr mortgage rate fell 3 basis points to 6.06% while the 15-yr dropped 5 bps to 5.57%. The 1-yr adjustable rate mortgage bumped up to 5.37%.


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Monday, 10/31 -

12:17  Snow to press China for further revaluation of yuan.

12:09 Snow says US needs to exercise fiscal discipline and that projections are indicating the budget deficit will be cut in half by 2009.



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published 10/31 by Standard & Poor's Equity Research -

In the market environment we foresee, swinging for the fences may not produce the best results.

                                       

As the 2005 World Series again demonstrated, one of the great thrills in baseball is the grand slam. Nothing brings the crowd to its feet like seeing four runs score from one long-ball hit. But most games aren't won with grand slam home runs. Singles and doubles are the daily workhorses of the national pastime.

That's a lesson we think investors should remember. Despite the hype that always seems to surround hot stocks, investment grand slams are few and far between. And we believe that people reaching for them are more likely to strike out, as they did when the tech bubble burst in 2000.

So what are the stock market equivalents of singles and doubles? We think they are the slow and steady returns you can get from stocks of companies that offer consistent earnings and dividend growth. A quick way to identify many of these investments is to look for stocks that have been accorded above-average S&P quality rankings. That means stocks ranked A-, A, and A+ for growth and stability of earnings and dividends over the past 10 years.

We currently recommend an overweight position in two market sectors, consumer staples and health care. Sam Stovall, Standard & Poor's chief investment strategist, notes that 80% of the consumer staples stocks in the S&P 500 have above-average quality rankings, as do 49% of the health care issues in the index.

Not surprisingly, stocks in these two sectors also show a high return on invested capital (ROIC). For consumer staples stocks in the S&P 500, the five-year compound annual growth rate for ROIC is 14%. For heath care stocks in the index, it's 13%.

High-quality consumer staples and health care stocks ranked four or five STARS by Standard & Poor's analysts look to us to be a good choice in the market we foresee. They may not be grand slams, but singles and doubles can make you a winner.




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Wednesday, 11/02 -

07:45  Mortgage Applications

The weekly MBA mortgage applications index dropped -4.8% last week to the lowest level since April 2005, with purchasing applications dropping -6.2%, and refinancing falling -2.8%. The fixed 30-yr mortgage rate rose 15 basis points to 6.21% while the 15-yr rose 18 bps to 5.75%. The 1-yr adjustable rate mortgage bumped up to 5.39%.


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Tuesday, 11/15 -

03:53  Housing market shows further signs of cooling - WSJ

The Wall Street Journal reports the pace of U.S. home sales is showing further signs of slowing, amid a widening gap between sellers' asking prices and the amount skittish buyers are prepared to offer, according to an industry survey, real-estate brokerage firms and housing economists. Rising mortgage rates, higher energy costs, widespread talk about the risk of a "bubble" in housing and a surge in the number of homes on the market are among the factors behind the apparent slowdown. They have combined to make home shoppers more cautious, economists and real-estate brokers say. Buyers are taking their time to look for bargains, while many sellers have put unrealistically high price tags on their homes. That leads to a standoff, causing the number of sales to drop -- a classic ending to a period of unusually rapid house-price increases.



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hiker

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07:29  Mortgage Applications

The weekly Mortgage Bankers Association applications index fell -0.6% in the week ending Nov 11, with a refinancing drop-off of -5.4%%, while purchase applications rose 2.6%. The fixed 30-year mortgage rate hit 6.33% from 6.31% while the 15-year rose 2 basis points as well to 5.87%. The 1-year adjustable rate mortgage rose to 5.46%.

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hiker

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07:29 Mortgage Applications

The weekly Mortgage Bankers Association applications index fell -0.6% in the week ending Nov 11, with a refinancing drop-off of -5.4%%, while purchase applications rose 2.6%. The fixed 30-year mortgage rate hit 6.33% from 6.31% while the 15-year rose 2 basis points as well to 5.87%. The 1-year adjustable rate mortgage rose to 5.46%.

Market Insight published 11/14 by S&P Equity Research:

History suggests that investors have paid little heed to most political scandals, with one notable exception.

                                       

With the recent indictment and resignation of I. Lewis Libby, the Bush Administration has fallen into what looks like a historical pattern of second-term scandals. After World War II, every President who triumphed in his second encounter with voters has seen ethical problems surface. Though it is far from the principal issue in the current situation, investors want to know how the scandal could affect stocks.

In Dwight D. Eisenhower's second term, his chief of staff, Sherman Adams, was accused of accepting a vicuna coat from a businessman seeking access to the President. Adams was forced out in 1958. That year, the S&P 500 gained 38.1%.

Richard M. Nixon's second-term Watergate troubles need no introduction. The cover-up following the June 1972 burglary of Democratic National Committee headquarters came to a head in 1974. In that year, the Supreme Court ordered Nixon to turn over his secret tape recordings, and the House Judiciary Committee recommended impeachment. Before the full House could vote, the President resigned in August 1974. The S&P 500 fell 29.7% that year.

Ronald Reagan's Iran-Contra scandal had its origins in a covert effort by the National Security Council to sell arms to Iran and divert the profits to the Contras, who were fighting against the Marxist government in Nicaragua. Both the arms sales and the aid were prohibited by law. NSC staff member Oliver North was fired when his activities were discovered in 1986. The "500" gained 14.6% that year. In 1988, former NSC head Robert McFarlane pleaded guilty to withholding information about Contra aid from Congress. The index rose 12.4%.

In 1998, the House voted to impeach Bill Clinton for lying under oath about his sexual exploits. The market rose 26.7% that year and another 19.5% the following year when the Senate voted to acquit.

Do such scandals hurt stocks? History suggests that equities tumble only when the President appears likely to be removed from office.

--------------------

published 11/7 -

Both bulls and bears have valid points about the market, earnings, and the economy. We don't see either side prevailing in the near term.

                                       

Recent strength in stocks has given some people the confidence to predict that equities are headed straight up. But we believe the market is likely to bounce within a fairly tight trading range through the end of the year.

Some of the factors we think will cause cross-currents in the market in the weeks ahead are: seasonal strength vs. technical weakness; good corporate earnings vs. decelerating profit growth; and solid economic growth vs. a potential consumer pullback.

There is no question that the fourth quarter is usually the best period for stocks. In the years after World War II, the S&P 500 has chalked up an average advance of 4.3% in the final three months of the year. But Mark Arbeter, Standard & Poor's chief technical strategist, believes that the easy gains from the October low have already been seen. "Longer-term technical indicators and chart formations remain bearish," he says. Arbeter sees S&P 500 chart resistance and trendline resistance becoming a factor between 1220 and 1245.

Corporate profits remain strong. With 80% of the stocks in the S&P 500 having reported their September-quarter earnings, we estimate a 12.3% gain from the same period a year ago. That would represent the 14th consecutive quarter of year-over-year double-digit percentage growth in S&P 500 operating earnings. But for the full year, we expect growth of 14% in index operating earnings, down from a 24% increase in 2004.

The economy continues to do well. Gross domestic product increased at an annual rate of 3.8% in the third quarter, according to the government's advance estimate. Third-quarter non-farm productivity surged 4.1%, the best showing since the second quarter of 2004. But consumer confidence continued to fall, and unit vehicle sales dropped sharply in October, both of which we attribute to still-high energy prices.

Until something develops to push stocks meaningfully in one direction or the other, we think a trading range is the likely scenario.



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hiker

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Market Insight published 11/21 -

A gathering that will occur next month and one that took place on
November 10 could have implications for investors.

                                       

The next meeting of the Federal Open Market Committee (FOMC), the part of the Federal Reserve that sets targets for the fed funds rate, is set for December 13. We expect another increase.

Each of the last 12 FOMC meetings ended with a quarter-point boost. But Alan Greenspan's term as Fed chairman expires after the January 31 meeting. David Wyss, Standard & Poor's chief economist, suggests that the Fed might raise short-term rates by 50 basis points on December 13 to signal the end of the current round of tightening.

He contends that such a move would allow Ben Bernanke, the likely new chairman, more freedom in setting policy. "If the Fed raises rates a quarter point in both December and January, it will be hard for Chairman Bernanke not to raise again in March, and we will probably end at 5% instead of 4.5%," says Wyss.

There is not much difference for the economy between fed funds at 4.5% and 5%. Even so, we think stretching out the process could pressure stocks.

On November 10, the Financial Accounting Standards Board (FASB) met to discuss whether to put the weighty subject of pension accounting on its agenda. It decided to tackle pension reform, in two phases. In the first phase, FASB plans to require companies to put pension assets and liabilities on their balance sheets by the end of next year.

In the second phase, the FASB plans to tackle the various assumptions companies can make when calculating net pension expenses or income. At the start of each year, companies are now permitted to assume high returns on their pension assets. Even if they are not achieved, these "returns" can be used to boost earnings.

The FASB will begin to address how to remedy this problem. We think the discussion, though necessary, is likely to cause investors to reconsider some companies' earnings reports.




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hiker

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Market Insight published 11/28 by S&P Equity Research:

We don't underestimate the ability of the American consumer to shop, but home heating bills could affect sales this season.

When mathematicians assume that the value of an unknown follows logically from a series of known values, it's called extrapolation. For most other people, projecting the future from current conditions is called guessing.

Guessing was rampant on Wall Street during the dot-com bubble. Because share prices surged for companies that had no earnings and little more than an idea for a business, many people guessed that we were seeing a new investment dynamic. They seemed to believe that as long as new dot-com companies went public to fuel the interest of speculators, the market couldn't tumble. The last bear market proved that theory wrong.

Lately, we've been hearing from a number of people that, because the weather so far has been fairly mild, we are not likely to suffer through a harsh winter. These predictions are not being made by professional meteorologists, most of whom are loath to forecast the weather more than a week ahead.

We don't know if the approaching winter will be mild or brutal. But as the season progresses, it's a good bet that many people will be turning up their thermostats. On average, the Energy Information Administration estimates that U.S. households using natural gas for heating will spend 41% more this winter than last. For homes that use heating oil, the average increase should be about 27%, according to the agency. As the driving season turns into the heating season, we suspect that many consumers will shift their focus from the lower cost of gasoline to the higher price of heating fuel.

Standard & Poor's expects that retail sales in this holiday period will likely rise 3.5% to 4%. That's less than the 6.7% increase reported for the 2004 holiday season by the National Retail Federation. But a cold winter that hits during the pre-Christmas shopping rush could cause some consumers to trim their gift budgets even more.

We expect retailers will be watching the local weather forecasts closely this year.



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hiker

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published 12/12 by S&P Equity Research -

The economy and corporate profits are strong, and valuations appear attractive. In our view, quality should win out.

                                       

Looking back over the past five years, investors in large-cap stocks have had little to cheer about. The average annual price change for the S&P 500 has been negative, and growth stocks in the index have fared even worse than the benchmark.

This mediocre performance comes at a time when corporate earnings have generally risen. Operating earnings on the S&P 500 rose from 56.13 in 2000 to an estimated 76.80 in 2005, a gain of 36.8%. And that overall gain came despite a 31% decline in operating earnings in 2001.

One way to understand the anemic performance of large-cap stocks in the past half decade is to see it as a reaction to the huge advance in the bubble years of the mid-1990s. From the end of 1994 through 1999, the S&P 500 rose 220%, or 3.5 times the growth of operating earnings in that period.

Things even out a bit if you take a somewhat longer view. Though the S&P 500's compound annual change for the five years ended November 30, 2005 is -1.02%, that figure for the 10 years ended on the same date is 7.5%.

For 2006, we see the S&P 500's total return at 8.5% as the economy and corporate profits continue strong. Specifically, Standard & Poor's economists expect the real gross domestic product in the U.S. to increase 3.4% in 2006. We see inflation, measured by the consumer price index (CPI), remaining muted at 2.4% and core CPI, which excludes volatile food and energy prices, at 2.3% for the coming year. We think the projected $200 billion likely to be spent on rebuilding efforts in the wake of Hurricane Katrina will contribute to growth in the first half of 2006.

Corporate profits should continue to rise, albeit at a somewhat slower pace next year. Aggregating Standard & Poor's analysts' earnings estimates, we project that operating profits on the S&P 500 will advance 11.5% to a record 85.60.

We expect that a larger part of those profits will benefit shareholders via dividends and stock buybacks. Through December 7, Standard & Poor's logged 300 dividend increases by companies in the "500" this year. As a result, we now expect dividends on the index to total 22.10 in 2005. With the payout ratio of the "500" low by historical standards, we see room for additional dividend increases in 2006. For next year, we project S&P 500 dividends will total 24.50, a 10.9% advance.

Cash on the balance sheets of nonfinancial companies in the S&P 500 hit another record in November, at $638 billion. This has enabled companies to increase their share buyback programs. In years past, some companies used buybacks to offset shares issued in conjunction with exercised options. Now that options have to be expensed, we are seeing less of this activity, and buybacks are actually reducing shares outstanding. Over the 12 months ended September 30, 61 issues in the S&P 500 have lowered their share count by at least 4%. We think this has positive implications for per-share earnings and, therefore, stock prices.

In our view, the S&P 500 is attractive at a current multiple of 16.5 times our estimate of 2005 operating earnings. That compares favorably with the 19.8 average P/E ratio on estimated operating earnings for the period 1988 through 2004. In addition, relative to bond yields, the current 6% earnings yield of the index (the inverse of the P/E) suggests to us that the market is undervalued.

We expect that the yield of the 10-year Treasury will rise slightly, reaching close to 5.2% in the third quarter of 2006. This should come as the Federal Reserve's efforts to quell any incipient inflation begin to affect longer-dated debt instruments. In our view, the Fed is likely to halt its current round of tightening with the fed funds rate at 4.75%, perhaps in the first quarter of 2006. We also see oil averaging $56 a barrel next year, providing some degree of price stability.

One risk to our forecast is that the Fed could continue tightening short-term rates to the point where the economy slides into recession. However, given the measured pace at which the Federal Reserve has been moving, we consider this scenario highly unlikely. A less quantifiable risk involves energy. Should the Gulf of Mexico suffer another hurricane season like the last one, damage to the energy infrastructure could cause oil prices to spike.

We think it is an appropriate time to consider higher-quality stocks. Recently, stocks with above-average Standard & Poor's quality rankings have not performed as well as lesser-quality issues. Our research suggests that such underperformance of high-quality stocks (those above the ranking of B+) is cyclical, and likely to revert to a more normal pattern before long. Over longer time periods, stocks that have above-average growth and stability of earnings and dividends for the preceding 10-year period have tended to outperform.

We see the S&P 500 ending 2006 at 1360, for a 6.7% advance over the 1275 we now forecast for the end of this year. The projected advance is modest in part because the bull move that began in October 2002 is getting a bit long in the tooth. Furthermore, corporate profits, though growing, are doing so at a slower pace. Nevertheless, the advance we see is not far below the 7.6% average annual gain that the S&P 500 has posted since 1929.

We recommend that you keep 45% of your investment assets in domestic stocks, 20% in foreign equities, 20% in short-to-intermediate-term debt instruments, and 15% in cash. Among sectors of the market, we currently favor consumer staples, health care, and financials.




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published 12/19/05 -

In the face of two potentially frightening numbers, Wall Street proved that it really isn't superstitious.

                                       

When the Federal Open Market Committee (FOMC) raised short-term rates for the 13th time on December 13, nobody was surprised. And despite ancient fears of the number 13, the market wasn't spooked. In fact, it rallied. Clearly, Wall Street doesn't suffer from triskaidekaphobia.

More likely, many market participants now feel fairly certain that the Fed is close to the end of its tightening cycle. We agree, but there's nothing new in that. Standard & Poor's economists have been forecasting that the tightening will end when the fed funds rate (what member banks charge each other for overnight loans) reaches 4.75% sometime in the first quarter of 2006. So what's different?

The statement by the Fed did not include the familiar wording that "policy accommodation can be removed at a pace that is likely to be measured." In other words, the 25-basis-point increase that has become the hallmark of recent Fed meetings will no longer be automatic. Instead, the Fed will let the economic data determine whether rates should go higher. Some traders assumed that the end of automatic rate increases meant the end of all rate increases.

Two days after the Fed action, stocks weakened. We think this came from the realization on the part of traders that the tightening is not over yet. That day's report of a 0.7% rise in industrial production for November, on top of the 1.3% jump in October, caused some people to worry about rate hikes once again.

In our view, those fears are overblown. The year-over-year change in the consumer price index decelerated to 3.5% in November from 4.3% in October as energy prices retreated. And high fuel costs don't appear to have seeped into other prices. Core CPI, which excludes food and energy, remained stable at 2.1%.

Overall, we see the Fed hiking rates only two more times, and think this augurs well for stocks in the coming year.




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published Jan 3 by S&P Equity Research -

We think that the current shape of the yield curve has more to do with overseas investors than imminent recession.

                                       

The week between Christmas and the New Year tends to be somewhat boring on Wall Street. Many of the Street's usual denizens depart for vacations in warmer climes or spend the week hibernating.

But the typical inter-holiday torpor was disrupted recently by a troupe of dancing bears, who appeared happy to be roused by what they perceived to be a negative omen. We think their sleep was unnecessarily interrupted.

An inverted yield curve was the main cause for the adrenaline rush among Wall Street's ursine crowd. Late on the first trading day after Christmas, the two-year Treasury note traded with a yield that was four one-thousandths of a percentage point higher than the yield on the 10-year note. That's $0.04 annually on a $1,000 investment, an amount that most bond traders would not stoop to pick up on the sidewalk. In the last three trading days of 2005, the yield curve slightly inverted two more times.

An inverted yield curve is rare and often presages an economic downturn. The last one occurred in 2000, before the dot-com bubble burst. This time, the bears celebrated by knocking the market down by almost 1% on the first day the curve inverted.

But with such a small difference between the two-year and 10-year notes, should we really say the curve is inverted? Rather than inverted, we think the yield curve is better described as flat as a pancake. (Even pancakes have small air bubbles.) In our opinion, the reason is that foreign investors continue to stash their considerable savings in U.S. Treasury notes. This increased demand has depressed yields on longer-term fixed-income securities while the Fed has been boosting short-term rates.

Standard & Poor's economists believe that the economy remains in good shape, and they don't see a recession on the horizon. Nevertheless, if the yield curve does not revert to normal soon, the Fed may decide to stop tightening just to calm investor fears.




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Market Insight for April 10, 2006

Teaching the Dogs a New Trick
By Beth Piskora, S&P Global Editorial Operations



A popular income-oriented investment strategy
gets a little boost from S&P research.
                                       

Investors who are interested in income from their portfolios are often told to follow the Dogs of the Dow theory, where you buy the 10 highest-yielding stocks in the Dow Jones industrial average.

The only problem is that if you followed this advice for the past few years, you probably lost money. The Dogs of the Dow is less of a purebred and more of a mutt. In 2005, the aptly named Dogs fell 8.9%. In 2004, they posted only a 4.4% gain. In 2002, they were down 8.9%, following a 4.9% decline in 2001. Of the past five years, only 2003 stood out as a good year for the Dogs; they were up 28.7%.

We think it’s time to teach these Dogs a new trick. The whole reasoning behind the Dogs of the Dow theory is that you get a combination of capital gains and dividend income. But too often, these stocks do not post capital gains at all.

We overlaid S&P STARS rankings on the Dogs of the Dow, to come up with some recommendations. As you can see from the table at right, with the S&P overlay, only five of the Dogs pass muster. That’s up from four at the beginning of 2005.

In general, S&P expects investors to begin rotating their investments out of small-cap and speculative issues and into larger-cap, high-quality names. While the ability to pay out a regular dividend is certainly one measure of high quality, it is not the only one. In fact, the S&P 500 Growth index has 89 stocks with above-average Quality Rankings, whereas the S&P 500 Value index has only 62. Savvy investors will continue to search for good investment opportunities in both the growth and value universes.


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Market Insight for April 17, 2006

Double-Digit Earnings Growth — Barely
By Sam Stovall, S&P Chief Investment Strategist
Per-share earnings estimates are moving a bit lower, but our forecast is basically upbeat.

                                       

The first-quarter earnings reporting season begins in earnest this week. As seen in the table below, which compares S&P equity analysts' estimates on December 31, 2005 with those as of April 4, 2006, S&P believes operating earnings for the companies in the S&P 500 will have increased 11%, spurred by above-market gains for the energy, health care, and industrial sectors. Financials, information technology, telecom services, and utilities are expected to post below-market gains, while the consumer staples and materials sectors are likely to report year-over-year declines in earnings.

Even though S&P equity analysts expect the S&P 500 to post its 16th consecutive double-digit increase in year-over-year operating earnings during the first quarter, the gap between success and failure has narrowed since the end of last year, when we forecast a 13% advance in first-quarter results. Projections for the first quarter are also lower for eight of the 10 sectors in the S&P 500, with the outlook for the consumer staples sector slipping into negative territory. Only our estimate for companies in the financials sector has improved, albeit modestly.

Over the course of the first quarter, full-year 2006 forecasts for seven sectors also have been trending lower. We believe higher interest rates and elevated oil prices, along with a strengthening of the U.S. dollar over the past year and more modest increases in consumer spending, are likely to be the stated reasons for the more moderate results.

Even though our equity analysts' full-year forecast of operating earnings for the S&P 500 has held fairly steady (now a 10% gain is estimated vs. an earlier 11% projection), the small-cap story is a bit different. We initially expected to see a 19% increase in earnings for the S&P SmallCap 600 index in 2006. Now, however, we predict a 17% advance. What's more, small-cap stocks may be getting pricey, in our opinion, as they sport an average P/E ratio of 18.2 vs. 15.4 for large-caps, based on these reduced 2006 estimated earnings.

Is it time to pull the plug? Not just yet, in our opinion. S&P's Investment Policy Committee continues to project a 1360 yearend 2006 price level for the S&P 500. We believe this 9% price appreciation will likely be achieved by healthy economic growth, an end to the Fed's rate-tightening program at mid-year, a resulting renewed weakening in the U.S. dollar (which could aid exports), and an eventual moderation of energy prices. The valuation of the S&P 500 remains attractive, in our view. At 16.3 times trailing 12-month operating earnings, it is 17% below the average trailing P/E of 19.7 since 1988, when S&P first began tracking operating results. Even without a P/E expansion between now and the end of the year, 84.34 in projected per-share earnings for the S&P 500 would translate into a yearend price of 1375. We therefore recommend staying the course with equities.


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Market Insight for May 1, 2006

G-Whiz
By Alec Young, S&P Equity Market Strategist
G-7 rocked international markets, but we still see good times ahead for U.S. investors in foreign equities.

                                       

The Group of Seven leading industrial nations generated a lot of headlines over the past week, after the international organization urged emerging-market countries with large current account surpluses not to restrain appreciation in their currencies.

G-7, which is made up of finance ministers from Japan, Germany, the United Kingdom, Italy, Canada, France, and the United States, singled out China, which many policymakers in the U.S. argue has kept its exports artificially cheap by strictly controlling its currency. A weaker currency tends to bolster exports by making their prices more attractive in foreign export markets.

Since Asian economies are heavily dependent on exports, currency appreciation is perceived as a negative for overall economic growth and exporter earnings. Thus, the G-7 call depressed stocks around the region as Asian currencies rallied against the U.S. dollar in response to the statement. Selling was widespread and included stock markets in Japan, Taiwan, South Korea, Hong Kong, and Indonesia.

S&P Equity Strategy believes these concerns are overblown, because our analysis indicates that robust global growth will more than offset the negative effect of modest currency appreciation on Asian exports and corporate profits. It does not surprise us that, despite G-7-related selling, the S&P Asia 50 index was still up 12%, in U.S. dollars, this year through April 24.

In addition, we think it is important for U.S. investors to remember that a weaker dollar increases the value of their foreign investments.

This year through April 24, the dollar has fallen 4.9% against the euro and 2.8% against the yen. Standard & Poor's forecasts that the dollar will fall 10% against the euro and 7% against the yen by the end of 2006. European and Japanese stocks represent roughly 80% of equity market capitalization outside the U.S.

In Europe and Japan, our bullishness on the euro and yen is based largely on the wide interest rate differentials (which benefited the greenback last year) that are beginning to narrow as an end to U.S. rate hikes appears on the horizon. S&P Economics anticipates a May peak in the fed funds rate. We believe that, coupled with measured tightening by the European Central Bank (ECB) and the Bank of Japan (BOJ), an end to Fed rate hikes should render the euro and yen more attractive to global investors, as interest rate spreads shrink. S&P expects dollar weakness to accelerate in the second half of 2006, when we anticipate that ECB and BOJ tightening will have progressed further, giving capital markets more confidence in the central banks' tightening intentions.

We believe the dollar's fall validates the S&P Investment Policy Committee's recommendation of a 20% asset allocation to foreign stocks. The benchmark against which our allocation is measured calls for a 15% allocation to foreign issues, but we think a significant overweight position has been paying off — and will continue to pay off — for investors.

For example, the S&P Euro 350 index is up 13.8% in U.S. dollars so far this year. Without the currency conversion, that index has a gain of only about 9%. Similarly, the S&P Topix 150 index, a measure of Japanese stock market strength, is up 9.8% in U.S. dollars, but up only 7% without the currency conversion.

We continue to support our overweight recommendation for foreign equities.


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Market Insight for May 10, 2006

Q2 Preview
By Howard Silverblatt, S&P Senior Index Analyst
As consumer spending likely slows,
we think the profit picture won't be as bright in the second quarter.

                                       

The game isn't over yet, but let's declare victory for the first quarter and defeat for the second.

Based on the companies in the S&P 500 index that have reported so far, the first quarter looks very good and appears set to post a 13.7% year-over-year operating earnings gain, marking the 16th consecutive quarter of double-digit gains.

In the quarter, all 10 sectors posted increased earnings. Two-thirds of the companies beat Wall Street's consensus estimates, and three-quarters beat their results from a year ago. Energy sector earnings were up 39%, and those for health care companies rose 23%. Even the materials sector, which has been struggling for the past two quarters, managed a 4.5% gain.

Overall, the S&P 500 has put up four straight months of gains, to produce a 5.6% year-to-date total return (through April). So break out the non-alcoholic champagne, and let's celebrate. It's got to be non-alcoholic because we need to keep a close eye on the second quarter, which we think is not going to be as much fun.

Consumer spending, which made the 16 consecutive quarters of gains possible, is slowing down, from 5.5% growth in the first quarter to an estimated 3.2% in the second period. The first quarter started off with income taxes due, much higher winter heating costs in spite of reduced use, and near-record-high gasoline prices. Add flat income numbers, and you've got a recipe for reduced consumer spending, which we think should quickly translate into lower corporate profits for the second quarter.

There are also a couple of new wrinkles for the second quarter. The first is the rising number of companies that have reduced their share count. The $8.4 billion first-quarter profit that ExxonMobil recently reported represented a 6.9% increase from a year earlier, but the company's per-share earnings gain was 12%. That's because ExxonMobil reduced its share count by 4.6%. This also affected the oil giant's price-to-earnings ratio because that valuation measure is calculated using earnings per share. We expect more than 100 stocks in the S&P 500 to be in a similar situation in the second quarter.

Another wrinkle is cash. Cash on the balance sheet continues to go up, and now stands at an all-time high for the S&P industrials (the S&P 500, excluding financial services). So at this point, we also need to look at the impact of interest income. At current levels, income from a 5% instrument, reduced by the statutory tax rate, would increase earnings by 3.9%.

Considering the share buyback situation, upcoming headlines may not tell the full story. We think investors need to review a company's income statement to see where the earnings growth is coming from. In our view, companies will be hard pressed to maintain the double-digit growth that investors want to see. Two of the ways they achieve this growth -- share count reductions and interest income -- are legitimate, but they are also quite different from income derived from the company's business operations. We think investors should look for solid earned income growth and be a bit wary of growth from short-term fixes.


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5/22 - interesting market overview today by a news service, which is cross-posted as well at Yahoo Finance...it repeats the theme stated immediately above:

12:00 pm : Stocks still trade near their worst levels of the session midday as concerns of accelerating inflation on a global scale spark more unwinding of the excessive optimism that had the major averages trading at multi-year highs just a few weeks ago.

To wit, broad-based selling in overseas markets knocked all three major European indices down more than 2.0% while the Nikkei and Hang Seng lost 1.8% and 3.1%, respectively. Adding to this morning's struggles have been the indices inability to find support near key technical levels as concerns continue to mount as to where the industry leadership is going to come from over the second half of the year. Eight of 10 economic sectors are trading lower, with special emphasis on a 4.0% drubbing in semiconductors pushing the influential Tech sector further into negative territory for the year.

It's now apparent that investors are coming to grips with the reality that interest rates are not going to peak at a level at which economic and earnings growth will remain very strong. For instance, S&P 500 constituents Lowes (LOW 60.06 -2.58) and Campbell Soup (CPB 32.92 +0.27) both beat forecasts and issued upside FY06 EPS guidance, but both reports have been overshadowed by the realization that slower economic growth in the second half of the year will lead to slower profits and prompt analysts to adjust their forecasts accordingly.

On a positive note, investors are receiving some more relief on the commodity price front, as speculation that rising interest rates and a rebound in the greenback diminish demand for dollar-denominated commodities (e.g. oil, gold). However, the subsequent absence of leadership from Energy (-2.2%) and Materials (-3.1%) -- the year's best two performing sectors which are expected to contribute a significant portion of the profit growth on the S&P 500, is weighing heavily on the proceedings.

Another positive going unnoticed has been a sharp decline in the costs of borrowing, as the yield on the 10-yr note (+17/32) has broken through the psychologically significant 5.00% barrier. Be that as it may, one of the main catalysts restoring the safe-haven appeal of U.S. Treasuries has been a flight-to-quality bid in bonds at the expense of the sell-off in stocks and commodities.


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Market Insight for May 22, 2006

Global Dynamos
By Isabelle Sender, S&P Global Editorial Operations
The climate remains favorable for stocks of select firms servicing geographies where we think strong growth is likely to continue.

                                       

Standard & Poor's sees opportunities among certain multinationals with operations in India, the largest democracy in the world, where demand for what companies produce or provide continues to appear strong. We project that India's economy will grow by at least 7% annually for the foreseeable future, thanks in large part to the subcontinent's prosperous information technology sector, the resulting consumerism, and the concurrent investment in infrastructure.

India's English-speaking, highly educated workforce has been a source of low-cost technology and service labor. Now, it's also a growing consumer base. As such, we believe information technology (IT) firms with significant production on the subcontinent, along with industrials focused in the logistics industry, will likely outperform the benchmarks.

On a global basis, IT and business process outsourcing (BPO) services grew about 7% in 2005, while India-based IT/BPO companies grew 33%, according to Crisil Research, an India-based credit rating agency that is majority owned by S&P. Looking ahead, the compound annual growth rate for Indian exports is projected by Crisil to be 26% through 2009 for IT services and 31% for BPO services.

The table above shows highly ranked India-based companies that trade as American depositary receipts here and U.S.-based multinationals with significant Indian operations, all of which are expected to show material stock price appreciation over the next 12 months, in our opinion.

"Leveraging the increased efficiencies offered by global logistics advancements should enable multinationals from all over the world to expand their reach in tapping new markets to both sell and produce products," explains Alec Young, S&P equity market strategist. "Multinationals are leading the way in enabling productivity-enhancing global logistics."


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Market Insight for May 30, 2006

Roller-Coaster Ride
By Alec Young, S&P Equity Market Strategist
What does recent commodity volatility mean for stocks?

                                       

The major market indices have been on a roller-coaster ride in recent weeks. The volatility has been blamed, in part, on high commodity prices and the threat of inflation.

Despite a recent sharp correction, the Commodity Research Bureau (CRB) index is still up more than 40% since January 2003, with industrial, precious metal, and energy-related commodities the primary performance drivers. This year through May 22, West Texas intermediate crude oil was up 30%, gold 27%, silver 42%, and copper 78%.

With global gross domestic product expected to rise 4.9% in 2006, we believe investors have been shifting their attention to the dark side of strong growth: commodity price appreciation and the potential for rising inflation.

In our view, the overriding concern is that world central banks, fearing increased cost pressures, will raise rates too much and stifle global economic growth, in turn causing slower profit growth at companies. S&P Economics believes the U.S. Federal Reserve is now in a "wait and see" mode, with no new rate hikes planned for the coming months.

Although higher commodity prices are generally seen as a net negative for stocks because of their effect on profit margins and inflation, S&P believes these concerns are overblown for a number of reasons.

Within the S&P 500 index, energy and materials have been the best-performing sectors this year, rising 8% and 4%, respectively, as of May 22. Surprisingly, given their 14% combined weight in the index, they account for almost all of the index's modest year-to-date gain of 1.1%.

Recent equity volatility reflecting the inflationary impact of higher raw material prices is overdone, in our view, as inexpensive Asian imports are offsetting the inflationary effect of rising raw material prices in developed economies. In addition, wages, not commodities, represent the biggest share of the cost of goods sold, and U.S. companies have used benefit cutbacks to offset rising wages. We believe this has further muted the inflationary effect of higher raw material prices on core inflation.

With respect to profit margins, S&P Equity Strategy believes that fears regarding the negative effect of higher raw material costs are exaggerated. As manufacturing has declined as a percentage of the world economy, U.S. reliance on energy and industrial commodities has decreased, according to our analysis. By contrast, the less commodity-intensive services sector now commands a much larger share of gross domestic product in the world's largest economies.

In addition, S&P Equity Strategy believes that the outsourcing of production to inexpensive emerging market nations is helping to offset commodity-related margin erosion. Support for this thesis was shown in 2005, as operating earnings for the S&P 500 index rose 13%, despite a 28% annual rise in the CRB index. Our analysis indicates that this trend is continuing in 2006, despite commodity price appreciation. S&P analysts forecast a 12% operating earnings gain for the S&P 500 index in 2006.

S&P Equity Strategy notes that economically sensitive cyclical areas that have benefited the most from strong growth and ample liquidity are now experiencing the most volatility. This group includes higher-risk areas like emerging markets, Japan, mid-caps, and small-caps. S&P believes that investors should maintain a diversified portfolio, with exposure to all of those areas. Our current recommendation is a 3% allocation to emerging markets, 4% to Japan, 6% to U.S. mid-caps, and 4% to U.S. small-caps.

Similarly, at the sector level, cyclical areas like industrials, materials, energy, information technology, and consumer discretionary have fared worst, as they are seen as most vulnerable to slowing economic growth. S&P Equity Strategy recommends overweighting energy and financials and underweighting consumer discretionary, telecommunications, and utilities.

S&P Equity Strategy believes the recent market downturn presents a buying opportunity. We continue to recommend that investors keep 65% of their portfolios in stocks, with a 45% allocation to U.S. issues and 20% to foreign equities.



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Market Insight for June 5, 2006

When the Blue Chips Are Down...
By Isabelle Sender, S&P Global Editorial Operations
...Consider buying top-ranked stocks in beaten-up industries.

As rising interest rates and mounting inflation put a chill on global markets, escaping to the beach or boardwalk sounds increasingly appealing to investors. But for those who look at recent market volatility as a buying opportunity, we can offer some investment ideas.

In the summer months, expect lighter volume and increased volatility, says Sam Stovall, chief investment strategist at Standard & Poor's. However, Stovall believes that regardless of what direction the markets take in the coming months, investors could take advantage of the volatility by considering a value investing strategy.

"We think that investors could shore up their portfolios with stocks in industries that have lost ground during the recent volatility but that our analysts still consider buys or strong buys," Stovall explains.

To this end, The Outlook screened for the 10 most volatile, yet most favored, industries. We looked for those industries that, by the end of May, had fallen more than 5% since the market peaked on May 9. But we limited our search to those industries for which the average STARS ranking of stocks in that group was four or better (see table below). Readers can use the stock-screening tool on our website, http://www.outlook.standardandpoors.com, to identify the best opportunities in each of these industries.

Chart created June 1, 2006

"The resulting stock picks typically present an enhanced opportunity for investors to profit by buying when the price is deflated," Stovall says.

If this style of investing appears counterintuitive, the strategy actually is not. Value investors actively seek positions in assets that they believe the market has beaten up. For example, the "Oracle of Omaha," billionaire investor Warren Buffett, considers himself a value investor. He has stated publicly that he believes sometimes investors overreact to good and bad news, causing volatility that does not jibe with long-term fundamentals.


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Market Insight for June 12, 2006

Why It's a Good Time to Buy
By Beth Piskora, S&P Global Editorial Operations
Recent market downturns are making stocks around the world more attractive, in our view. At the same time, S&P analysts are raising their target prices for many issues.

Considering the volatility of world stock markets over the past few weeks, most of it on the downside, it is not too surprising that Standard & Poor's equity analysts have found more upgrade than downgrade opportunities. In the past five issues of The Outlook (including this one), there have been 132 rising STARS and 50 falling STARS. STARS are assigned according to the difference between a stock's current price and its 12-month target price. When the current price is falling, the potential gain gets larger, hence the upgrades.

But at the same time, S&P analysts have also been boosting their target prices. Analysts revise their target prices for any number of reasons -- better-than-expected profits, a lucrative new contract, the sale of a less profitable division -- but generally, the revisions are linked to signs of improving fundamentals.

Standard & Poor's studied the recent target price revisions and came to the following conclusions, all of which omit the effect of any dividends:

  • S&P equity analysts increased their 12-month target prices for issues in the S&P 500 by an average of 1.1% in May.
  • Based on our fundamentally derived target price forecasts, the S&P 500 is projected to reach 1,472 by May 2007. The S&P Investment Policy Committee target for year-end 2006 remains 1,385. From current levels, the target prices suggest a 10.6% increase by the end of this year and a 17.6% increase by May 2007.
  • Projected gainers outnumber projected losers seven to one, with 435 of the S&P 500 issues expected to gain over the next 12 months and 62 expected to lose. These breadth projections are the strongest since S&P started calculating expected breadth in 2003.
  • All 10 sectors of the "500" are expected to gain.
  • Energy remains on top, with 28 issues expected to gain and one to decline, resulting in an expected weighted sector gain of 20.8% over the next year. S&P Equity Strategy recommends an overweight allocation to energy, which makes up 10% of the "500." An exchange-traded fund (ETF) that tracks this sector is the Select Sector SPDR-Energy (XLE).
  • In the financial services sector, S&P analysts are expecting 76 issues to show 12-month price gains, and 10 to post declines. S&P has an overweight recommendation for financials, about 20% of the "500." An ETF option here is Select Sector SPDR-Financial Services (XLF).
  • Telecommunications looks like the weakest sector, with five issues expected to gain and three not, for an estimated weighted sector gain of 6.5%. S&P advises underweighting telecom, which makes up 3% of the "500."
  • Of consumer discretionary stocks, 71 are expected to gain and 15 to lose. S&P recommends an underweight position in this sector, 10% of the "500."
  • Thirty utilities stocks are expected to gain, and one to decline. S&P advises an underweight allocation to utilities, which make up 3% of the "500."




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Market Insight for July 25, 2006

Stocks Suffer as Rockets Fly
By Alec Young, S&P Equity Market Strategist
Overweight energy to hedge against geopolitical risk and record crude prices.

As if slowing earnings growth, rising inflation, and a tighter monetary policy weren't enough, the escalating conflict between Israel and Hezbollah is pushing geopolitical unrest to the forefront of investors' minds, and aggravating volatility in global equity markets.

As of Friday morning, July 21, Israel continued to pound Hezbollah positions in Lebanon and roadways between Lebanon and Syria, which with Iran sponsors the terrorist group. Israel is also warning inhabitants to flee southern Lebanon before a likely ground assault to establish a deep buffer zone. The crisis was triggered on July 11, when Hezbollah kidnapped two Israeli soldiers in a cross-border raid.

And, of course, the nuclear ambitions of Iran and North Korea are still lurking in the background. The United Nations Security Council, in a rare show of unity, condemned North Korea's July 4 missile tests. Pyongyang "vehemently denounced" the resolution, and thundered that it would "bolster its war deterrent for self-defense," believed to be a reference to its nuclear weapons program. Kim Jong Il, investors have been duly reminded, represents a real and present danger to Asian stability. Although his aim in making nuclear threats may be largely financial, we think his biggest bargaining chip, the possibility of a unilateral attack against his neighbors, remains. Tokyo and Seoul are within range of his missiles.

Moreover, the increasing intransigence of President Mahmoud Ahmadinejad suggests to us that Iran is determined to reject any form of cooperation, despite increasingly attractive financial "olive branches." On July 13, Ahmadinejad threatened to revise Iran's cooperation with international bodies monitoring its nuclear program.

The strong correlation between rising geopolitical unrest and record energy prices only exacerbates the latter's impact on world stock markets, in our view. With global oil production capacity tight, traders worry that oil prices are vulnerable to even minor supply disruptions. West Texas intermediate crude oil hit new all-time highs on July 14, surging to nearly $78 per barrel in the face of escalating tensions in the Middle East and renewed rebel attacks on Nigerian oil pipelines. Attacks by Nigerian militants this year have cut output of crude oil by 500,000 to 800,000 barrels a day. Nigeria is one of the top five suppliers of oil to the United States.

The S&P Investment Policy Committee recently lowered its 2006 year-end S&P 500 index target to 1315, representing price appreciation of 5% from year-end 2005. Although by no means the only headwind that equities face, geopolitical tensions are a significant reason for our more cautious second-half outlook. At the sector level, S&P Equity Strategy recommends overweighting the energy sector as a way of hedging the negative effects of increased geopolitical risk and stubbornly high oil prices. In addition to having what we consider excellent earnings predictability in uncertain times, the energy sector is the least expensive in the market, trading at 10.5 times estimated 2006 earnings vs. 14.5 for the S&P 500 index. The table on the cover lists our five-STARS picks in this sector.



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