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Fear vs. Fundamentals


By Sam Stovall Volatile stock prices over the past few weeks appear to have been driven more by fear than fundamentals -- fear that the jobs picture will not improve before the election (though the March employment report, released Apr. 2, provided some comfort to investors) and that international terrorist activities are on the rise.

While it's very hard to forecast fear, we at Standard & Poor's remain convinced that the fundamental picture is sound. Our economic outlook continues to call for a 4.6% advance in real gross domestic product in 2004. For this year's first quarter, S&P analysts expect the S&P 500-stock index to post a 17% year-over-year increase in operating earnings, led by a 75% jump for technology, a 79% climb for basic materials, and a 21% increase for financials. Consumer staples, energy, telecommunications services, and utilities are projected to show declines for the period.

MOSTLY SOLID. But that's just for the quarter just ended. What about the entire year? Take a look at the table below, which shows the percent change in 2003 and estimated 2004 operating earnings for sectors in the S&P 1500.

Operating EPS % Changes, Year-over-Year

S&P 1500 Sector

2003 (full yr.)

2004 (Q1)e

2004 (full yr.)e

Consumer Discretionary

11

28

21

Consumer Staples

-1

-7

2

Energy

67

-13

-4

Financials

27

21

10

Health Care

1

12

26

Industrials

5

27

16

Info. Tech.

151

75

58

Materials

10

79

50

Telecom. Svcs.

-1

-8

-1

Utilities

-8

0

1

S&P Composite 1500

19

17

16

S&P 500

19

17

15

S&P MidCap 400

24

25

20

S&P Small Cap 600

15

20

28

S&P analysts believe that despite an increase in share-price volatility during the second year of the bull market that started on Oct. 9, 2002, the market's economically sensitive sectors and industries are likely to show the strongest earnings growth and, as a result, record the greatest share appreciation in 2004.

We expect generally favorable economic conditions in the U.S. this year: Good growth in personal income, modest inflation, and a relatively benign (albeit rising) interest rate environment. The U.S. unemployment rate is projected to edge lower in 2004.

If no future war concerns or terrorist acts significantly heighten fear levels in the U.S., we look for consumer confidence to improve. This should lead to some release of pent-up demand, helping sales and profit levels of various consumer-related industries.

MATERIAL GAIN. The information-technology group is the sector with highest expected EPS growth for the year, and its fundamentals should show a more decisive comeback in 2004 than the gradual recovery in 2003. We consider one subindustry group in particular -- semiconductors -- to be an early play on a cyclical tech recovery, and we're positive on the chipmakers. Global chip sales for 2004 are expected to surpass the $204 billion achieved in the boom year of 2000 and move higher in 2005.

The sector with the second-highest EPS projection for 2004 is materials. S&P's pick of the subindustry groups with the brightest outlooks include aluminum, diversified chemicals, paper packaging, and steel (see BW Online, 3/3/04, "The Solid Steel Sector"). We think these groups will continue to benefit in 2004 as the U.S. economy strengthens.

Note to readers: The weekly industry momentum table will return next week. Stovall is chief investment strategist for Standard & Poor's


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