See Pressures Easing Soon

The underlying strength of the U.S. economy should manifest itself before long

By Arnie Kaufman

Investors here and abroad are saying there are better places to put money than U.S. stocks. We led world markets to the extremes of the late 1990s and we're taking a particularly big hit in the correction of those excesses now.

The U.S. dollar, long considered overvalued, has lost its momentum, a distinct disadvantage in the global competition for investment funds. In addition, our country is the primary target of a worldwide terrorist network. Our business ethics are being found wanting. And lower federal tax receipts, combined with increased spending on national defense, security and special interest projects, have turned our budget surplus into a growing deficit.

What isn't getting much attention at this time, though, is that structurally, the U.S. economy is in an enviable condition, thanks to wide deployment of technology, high productivity, effective monetary policy, a flexible work force and a reasonable balance between the profit objective and social needs. Since November, 1982, the economy has been in expansion phases for 217 months and in recession for just 19 months, an 11-to-1 ratio of growth to contraction that is easily a record.

The geopolitical situation is daunting just now. But barring a catastrophe, Americans will do what they have always done in dangerous times -- process the threat and go on with life (and continue spending). Beginning later this year, aided by a pickup in capital expenditures, GDP should settle into a growth pace that is above the long-term average. After a 2.8% rise projected for the third quarter, S&P chief economist David Wyss forecasts a 5% spurt in GDP for the fourth quarter of this year, followed by 4.4% growth in 2003.

Instances of accounting/reporting obfuscation and of conflicts of interest, meanwhile, are likely to be fewer and less egregious in the glow of regulatory, media and market spotlights.

Typically, stock market cycles are shorter and sharper on the downswing than the upswing, as selling tends to be concentrated and thus relatively rapidly exhausted. The S&P 500 is off 12% so far this year, following drops of 13% in 2001 and 10% in 2000. The last time it fell three full years in a row was 1939 to 1941, when it averaged a 13% annual decline. After 1939-41, however, the index posted double-digit gains (averaging 19%) for four straight years. Only one other time since then did the "500" drop for even two consecutive years, 1973-74. That was followed by a 31% gain in 1975 and a 19% rise in 1976.

S&P chief technical analyst Mark Arbeter notes that one of the most reliable market patterns is an important low at roughly four-year intervals, with most of these representing the final low of a bear market or major correction. One occurred in October 1998. Arbeter is looking for the next one between August and December of this year.

With p-e ratios still liberal, risks high and long-term interest rates likely to rise, market gains after the turn and in the years ahead may well be modest by the standards of the 1980s and 1990s.

We at S&P forecast that the S&P 500 index, which started 2002 at 1148 and is currently around 1007, will end this year at 1090 and reach 1155 by the middle of 2003. The prospects justify keeping 55% of portfolios in stocks. We would hold 20% in bonds and 25% in cash reserves for utilization as opportunities arise down the road.

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

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