Further Recovery Likely

S&P sees some evidence that investors are looking ahead to better conditions this year

By Joseph Lisanti

Before President Bush's economic plan became public, stocks shot up dramatically, only to fall when the particulars were explained. Although investors like the idea of tax-free dividends, the devil is in the details.

We suspect that the total elimination of taxes on stock dividends won't survive in the final version of the new law. Nevertheless, some break will be offered, and that is likely to boost the 70% of stocks in the S&P 500 that now pay dividends. It could also encourage companies currently sitting on large piles of cash to return some to shareholders. As the chart below shows, investors have favored dividend paying stocks over those that don't pay over the three-year course of the bear market.

Some of the recent see-sawing in stock prices has occurred because of earnings warnings. Many businesses have yet to see much growth in demand, and pricing power remains elusive. The weakness of the dollar against the euro could provide some cover as companies attempt to raise prices in the U.S. In addition, the declining greenback should improve the fortunes of U.S. exporters.

Major U.S. companies are starting their quarterly earnings reporting marathon, and near-term market action will depend on what they reveal over the next few weeks about the final quarter of 2002. Looking ahead, our analysts believe that 2003 earnings on the S&P 500 will come in at $54.25, up from the $46.70 we think will be posted for 2002.

In large part, the expected improvement in earnings is tied to a stronger economy. David Wyss, S&P's chief economist, looks for real GDP growth of 3.2% this year. Investors seem to sense that the economy is getting better. As evidence, we note that last Friday's disappointingly weak employment report for December caused little damage to stocks.

We expect the market to work its way higher over the course of the year, and advise keeping 65% of investment assets in equities.

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

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