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Earnings Growth Could Boost Stocks

By Joseph Lisanti We assume that most investors were glad to see the end of this year's first quarter. After a good advance in the aftermath of the November elections, stocks spent most of the first three months of 2005 treading water.

Some investors appear heartened by the S&P 500's bounce off of its late March low. Maybe they shouldn't be, according to Mark Arbeter, Standard & Poor's chief technical strategist. Arbeter notes that the rebound has not been particularly strong, and there was no significant trading volume on the upswing.

Notwithstanding the technical problems, we believe that corporate profits are a potential bright spot. The relative dearth of negative earnings preannouncements in the just-completed "confessional" season is our main reason for optimism. We think this indicates that first-quarter earnings, now being reported, will come in at least as good as expected and maybe better. Our estimate of full-year 2005 operating earnings on the S&P 500 continues to inch up, and now stands at 75.05, an all-time high.

Everyone knows that short-term interest rates are going up, albeit at the Federal Reserve's "measured" pace. The Fed has shown what we believe has been a remarkably light touch in this cycle. Consequently, the higher rates have not choked off spending in the economy, nor have they reached a point where fixed-income assets provide an attractive alternative to equity investments. The day will come when bonds, notes, CDs, and money market funds will again draw investor cash, but for now, we believe stocks have a little more breathing room.

As we see it, merger activity is likely to continue at a good clip, fueled in part by corporate cash. Standard & Poor's now estimates that the non-financial companies in the S&P 500 index have $618 billion in cash and equivalents on their balance sheets.

All of this suggests to us that, though it won't be an easy move, stocks could see some strength in the weeks ahead. Lisanti is editor of Standard & Poor's weekly investing newsletter, The Outlook

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