Wider Swings Ahead?

S&P sees a good chance that the range of the S&P 500 in 2005 will be broader than last year's

By Joseph Lisanti

Market volatility was fairly low last year. In 2004, there was only a 14.1% difference between the high and low on the S&P 500. That compares with 38.9% in 2003 and an average spread of 33.8% since 1928. We think there's a good chance that volatility will increase this year.

The relative lack of movement in the index last year was unusual and marked the fourth-narrowest spread between the annual high and low in the history of the S&P 500. We attribute the narrow range to several factors that appear to have restrained investors, including a close election race, higher oil prices, a weaker dollar, and a relatively soft job market for much of the year. The weaker dollar and its corollaries, rising oil and gold prices, may have enticed many hedge funds and other nimble traders to play in those greener pastures and ignore equities.

While the fast money crowd will still find currencies and commodities volatile in 2005, we believe that the stock market is likely to draw some of their attention. One reason is that we expect an increase in merger and acquisition activity that will cause an influx of "hot money" trying to anticipate the next deal. Non-financial companies in the S&P 500 have about $600 billion in cash on their balance sheets. Some of that money will go to dividend increases and stock buybacks, but we expect that M&A activity will consume its share of the pot.

U.S. multinational companies will have billions of dollars more at their disposal for M&A, thanks to the Treasury Department's clarification of the rules governing repatriation of foreign earnings under the American Jobs Creation Act. Enacted last October, this law taxes repatriated earnings of overseas subsidiaries at a maximum of 5.25% for one year. The rules don't allow the cash to be used for executive compensation or dividends, but acquisitions of U.S. companies generally qualify.

We look for M&A activity to increase in the months ahead.

Lisanti is editor of Standard & Poor's weekly investing newsletter, The Outlook

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