Stocks with Strong Upside Potential

If major indexes are getting back on their feet, which names could post the biggest gains? S&P has a number of candidates

After three weeks of red arrows, when the Standard & Poor's 500-stock index fell 6.4% and the S&P SmallCap 600 declined 7.8% (and 128 of the 137 subindustries in the S&P Composite 1500 index were in the red), Mark Arbeter, S&P's chief technical strategist, believes that based on the favorable end-of-day close, on Friday, Aug. 10, we may have successfully retested the 1430 level on the S&P 500.

In Arbeter's opinion, if the 1430 area holds, as he expects, then "we would likely see a strong rally develop and take out the recent closing high up at 1497…this would complete a very compact double bottom reversal formation and would suggest that the worst is over."

Should Arbeter be correct that this market is ready to move higher, what could trigger this relief rally, in our opinion, is a continuation of favorable earnings reports from the June-quarter reporting season and favorable outcomes for the economic reports in the week ahead.

Beating Estimates

Take a look at the accompanying table. So far, combining actual results with the remaining estimates for companies in the S&P 500, it appears as if the year-over-year increase in operating EPS will reach 11.0%, eclipsing our June 29 estimate by more than 100%, and our Dec. 29, 2006 projection of 8.5% by nearly 30%.

Additionally encouraging is that seven of the 10 sectors in the "500" will likely see better results than earlier anticipated, implying the buoyancy did not come from a minority of groups. Specifically, Financials, Health Care, and Telecom Services should see double-digit increases this quarter. Only Consumer Discretionary will likely post a decline.

This week there will be more than 10 economic releases. In particular, we think investors will pay close attention to the retail sales, PPI, CPI, industrial production, housing starts, and University of Michigan consumer sentiment reports. Should the consumer and industrial surveys come in weaker than anticipated, while inflation remains benign or even moderates, we believe investors will feel heartened that the Fed soon will start lowering short-term interest rates. Indeed, Fed funds futures indicate increased expectations for a Fed rate cut by the September FOMC meeting.

What's more, S&P economist Beth Ann Bovino wrote on Aug. 10, "After the [Aug. 7] FOMC statement, we expected that the Fed would remain on hold through year-end, with policy easing likely in January, 2008. But the Fed's actions indicate to us that they are aware of the liquidity constraints in the market and they are willing to do whatever it takes to keep markets functioning fairly effectively. The Fed's market action makes it more likely that it will cut rates earlier, possibly at September's FOMC meeting."

Setting the Screen

Should this near-term rally materialize, what do S&P equity analysts think are the best opportunities? S&P's 65 U.S. equity analysts cover nearly 1,600 stocks, for which they issue buy, hold and sell rankings, as well as projected 12-month target prices. Screening for 5-STARS (strong buy) stocks with the highest differences between recent and target prices (using www.advisorinsight.com), I show up to three representatives for each sector, with Trump Entertainment (TRMP), Six Flags (SIX), Assured Guaranty (AGO), Maidenform Brands (MFB), and Medicis Pharmaceutical (MRX) offering the greatest upside potential.

5-STARS Stocks with Highest 12-Month Price Appreciation Potential
S&P Sector Company Ticker Curr. Price Tgt. Price % Chg.
Consumer Discretionary Trump Entertainment TRMP 7 14 106
  Six Flags SIX 4 8 104
  MaidenForm Brands MFB 16 27 67
Consumer Staples Altria Group MO 67 85 26
  CVS Caremark CVS 38 46 21
  Walgreen Co. WAG 46 56 21
Energy Statoil ASA ADS STO 28 40 45
  Mariner Energy ME 21 29 39
  Swift Energy SFY 38 52 36
Financials Assured Guaranty AGO 24 42 75
  Allstate ALL 52 75 44
  Wachovia WB 47 67 41
Health Care Medicis Pharmaceutical MRX 27 42 55
  ICON Plc ADS ICLR 44 64 45
  Thermo Fisher Scientific TMO 53 74 39
Industrials Trinity Industries TRN 37 55 49
  Landstar System LSTR 44 61 38
  Pike Electric PEC 20 27 38
Information Technology Corning GLW 23 33 41
  Citrix Systems CTXS 34 46 36
  EMC Corp. EMC 18 24 35
Materials Glatfelter GLT 14 18 28
  FMC Corp. FMC 85 105 24
  Airgas ARG 46 56 23
Telecom. Svcs. Citizens Communications CZN 14 17 26
Utilities NICOR GAS 41 53 28
  Entergy ETR 98 119 21

Source: Standard & Poor's Equity Research; Data as of 8/10/07

Should we get the relief rally we expect, don't get too complacent and put everything on autopilot. Arbeter cautions that even if the S&P 500 does hold around 1430 and subsequently rallies, he still expects more testing sometime later in August or September. So remember to check back frequently.

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