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Case for Further Gains

By Arnie Kaufman The recovery in the S&P 500 index from September 21 to date has roughly matched in magnitude and duration the bounce off the low in early April this year. The 19% rally in the "500" over about seven weeks last spring was the strongest since the market peaked in March 2000, but it then gave way to renewed decline.

We believe the current upswing will fare better than the one last April and May. The main reason is that the economy, which was just on the verge of contracting in April, is well along in the recession now and thus closer to the beginning of a new expansion phase.

Federal Reserve monetary ease, initiated in January, only begins working in a general way after about a year. The policy was in effect for too short a time to help in April, but it should start boosting the economy soon. Short-term interest rates are now about half their level at the comparable point of the April-May rally, while long-term rates are down more than a percentage point since then. Lower rates, aside from stimulating business conditions, make stocks a more appealing investment alternative than money market instruments and bonds.

Fiscal stimulus is building up to massive proportions. The $75 billion to $100 billion package currently in Congress is on top of some $60 billion of federal spending on defense, security and rebuilding and $40 billion of tax rebates. None of this was at work last spring.

Crude oil prices, despite a bounce late last week on talk of production cuts, are roughly 25% lower now than they were last April-May, leaving consumers and businesses with additional money to spend on other things.

A better "season" lies ahead for stocks than was the case six months ago. Since 1928, average monthly gains in the S&P 500 have been more than twice as large from November through April as from May through October. The best two consecutive months of the year have been December and January.

Investor negativism was far greater at the recent bottom than at the low last spring, and is now greater than it was at the comparable point of the April-May rally. This should be viewed as a positive, according to S&P technical analyst Mark Arbeter. Extreme fear leads to a rush to salvage capital, producing irrational and excessive selling, which is what took place immediately after the terrorist attacks. Disbelief in a rally usually extends the life of the rally, as it implies that skeptics are available for later conversion to buyers. Kaufman is editor of Standard & Poor's weekly investing newsletter, The Outlook

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