Back on the Defensive

The market has lost some of its recent resiliency, but S&P sees improvement before too long

By Arnie Kaufman

Investors have turned more cautious again. They see no urgency to buy in the face of mixed signals from the economy, the prospect of a U.S. attack on Iraq, the poor start to what historically has been a weak season for the market, and predictions by many strategists that returns on stocks are likely to be modest for years.

In addition, technical conditions are not supportive. Trading volume on up days is too low, many key stocks are facing heavy overhead resistance and sentiment during rallies turns bullish too quickly, according to S&P chief technical analyst Mark Arbeter.

Arbeter feels the chances are good that that the July 23 low of 797.70 on the S&P 500 will undergo a nearby test. He notes that the severe price weakness in the period leading up to the July low (a 10-day rate of change of minus 16%) and the unusually high number of individual-stock lows (27% of all NYSE issues traded) on the index's intraday low day of July 24 are in line with the rate-of-change and new-low numbers that in the past have seen a low followed by a test of that low.

Not all is bleak, however. Despite the generally disappointing news lately, high productivity should allow the economy to grow at a decent pace without inordinate inflation and interest rate increases, and should also aid corporate profit margins. GDP remains on target to expand at a pace of 3% or more well into 2003. Operating earnings on the S&P 500, though coming off a deeply depressed base, are expected by S&P analysts to rise 25% this year and another 20% next year. Accounting scandals should be less of an issue, and while the Iraqi situation poses high risk, a quick and favorable resolution could boost stocks.

Valuations are reasonable after taking into account the low returns of alternative investments. We at S&P think that six to 12 months from now, the market will be nicely above current levels. Maintain a positive investment approach.

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

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