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Profits Are Stronger Than Investors' Nerves

By Sam Stovall How are second-quarter profits for Corporate America shaping up? Not bad. With more than 80% of the companies in the S&P 500 index having reported June-quarter earnings, S&P estimates that results will again be better than expected.

As can be seen in the table below, S&P analysts projected second-quarter earnings for the S&P 500 to rise 24% on a year-over-year basis, with leadership coming from the Information Technology, Materials, and Energy sectors. Thus far through the cycle, however, the Standard & Poor's 500-stock index is on track to post an earnings increase in excess of 27%, with 8 of the 10 sectors posting actual quarterly results that top earlier estimates. In addition, full-year 2004 estimated results have improved as well, with a 21% advance projected for the "500," a 24% gain for the S&P MidCap 400, and a 37% jump for the S&P SmallCap 600.

STRONG SHOWING. What's more, these stellar second-quarter performances weren't just the result of belt-tightening efforts. S&P estimates that sales for the period increased 11% for companies in the S&P 500.

S&P Composite 1500 Q2-2004 Operating EPS


Q2 2004 Y/Y

% Chg.


% Chg.

6/28 7/27 6/28 7/27

Consumer Discretionary 21 28 26 28

Consumer Staples 7 9 5 5

Energy 42 49 23 28

Financials 9 14 14 15

Health Care 36 36 25 24

Industrials 17 10 21 20

Information Technology 126 131 64 64

Materials 53 73 67 78

Telecommunication Services (16) (7) (7) (7)

Utilities 19 20 (1) (1)

S&P 1500 24 28 21 22

S&P 500 24 27 20 21

S&P 400 25 30 23 24

S&P 600 29 33 34 37

But even with the stronger-than-expected profits, the stock market has come under selling pressure in the past month. Investors recently turned sour on stocks, in our view, because they think that the best of the profit growth will soon be behind us. Even though full-year 2004 earnings for the S&P 500 are expected to rise 21%, ahead of the 18.8% advance recorded in 2003, earnings for 2005 are projected to gain only 10%.

While that's still an advance in absolute terms, the annual rate of growth is projected to begin slowing in the quarters ahead. S&P analysts expect year-over-year operating results for the S&P 500 to be up 15% in the third quarter. Fourth-quarter 2004 earnings advances are expected to be marginally stronger -- up 17% -- and we see only a 6% gain on average during the first two quarters of 2005. So with the various bricks in this wall of worry -- terrorism, oil prices, rising interest rates, decelerating earnings, and the possibility of the incumbent U.S. President being voted out of office -- there are many reasons for investors to be nervous.

TIME HEALS ALL? Yet, S&P's Investment Policy Committee still thinks there are also reasons to believe the S&P 500 should close with a gain for the year: An expected moderation in oil prices, a still-healthy economy, attractive valuations, and time. We believe oil prices will be trading around $38 per barrel by yearend, based on projections for worldwide economic growth and an eventual easing of the supply-disruption premium.

Real U.S. gross domestric product, on the other hand, while advancing only 3% during the second quarter, is expected to resume its upward slope and post a 4.6% increase in 2004 and climb nearly 4% in 2005. And even though many in the financial media mention high stock-market valuations, in reality the S&P 500's price-to-earnings ratio of 19.3 (based on trailing 12-month GAAP earnings) is more than 10% below the 20-year average of 21.5.

But in the long run, maybe the best catalyst for an upward move in the market will simply be the passing of time, allowing many of the things investors are worried about -- terrorism concerns surrounding the Republican convention and the Olympics, combined with the results of the upcoming U.S. Presidential election -- to have come and gone. Maybe, just maybe, investors will be able to focus purely on fundamentals once again.

Industry Momentum List Update

For regular readers of the Sector Watch column, here is this week's list of the industries in the S&P 1500 with Relative Strength Rankings of "5" (price performances in the past 12 months that were among the top 10% of the industries in the S&P 1500) and their proxies (the highest STARS-ranked companies in the subindustry index; tie goes to the largest market value) as of July 30, 2004:




Recent Price

Consumer Electronics/Consumer Discretionary

Harman International (HAR)



Diversified Metals & Mining/Materials

Peabody Energy (BTU)



Fertilizers & Ag. Chem./Materials

Scott's (SMG)



Homebuilding/Consumer Discretionary

Pulte Homes (PHM)



Internet Retail/Consumer Discretionary

eBay (EBAY)



Internet Software & Services/Info. Tech.

Yahoo! (YHOO)



Oil & Gas Equipment & Services/Energy

BJ Services (BJS)



Oil & Gas E&P/Energy

Apache (APA)



Oil & Gas Refining/Mktg./Energy

Premcor (PCO)




Carpenter Technology (CRS)



Tires & Rubber/Consumer Discretionary

Cooper Tire & Rubber (CTB)



Wireless Telecom Svcs./Telecom Svcs.

Nextel Partners (NXTP)



* S&P's stock appreciation ranking system for the coming 6- to 12-month period: 5 STARS (buy), 4 STARS (accumulate), 3 STARS (hold), 2 STARS (avoid), 1 STAR (sell).

Required Disclosures:

All of the views expressed in this research report accurately reflect the research analysts' personal views regarding any and all of the subject securities or issuers. No part of the analysts' compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed in this research report.

For Required Disclosure information and Price Charts for all STARS ranked companies go to, click on "Investment Research", and then click on "Required Disclosures & Standard & Poor's STARS vs. Closing Prices Charts".

Additional information furnished upon request to Standard & Poor's.

Disclaimer: This material is based upon information that Standard & Poor's considers to be reliable, but neither Standard & Poor's Investment Advisory Services LLC nor its affiliates warrant its completeness or accuracy, and it should not be relied upon as such. Assumptions, opinions and estimates constitute our judgment as of the date of this material and are subject to change without notice. Past performance is not indicative of future results.

This material is not intended as an offer or solicitation for the purchase or sale so any security or other financial instrument. Securities, financial instruments or strategies mentioned herein may not be suitable for all investors. This material does not take into account your particular investment objectives, financial situations or needs and is not intended as a recommendation of particular securities, financial instruments or strategies to you. Before acting on any recommendation in this material, you should consider whether it is suitable for your particular circumstances and, if necessary, seek professional advice. Stovall is chief investment strategist for Standard & Poor's

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