Stay with a Positive Approach

The economy and corporate profits look good, so S&P continues to advise keeping 60% of investment assets in equities

By Joseph Lisanti

Consumer sentiment fell last month. We attribute the weakness to the public's fear of unemployment. Even so, initial claims for unemployment insurance declined slightly. And by most measures, the economy is doing fairly well.

Inflation remains quiescent; on a year-over-year basis, the rise in core consumer prices (excluding volatile food and energy) is only 1.3%, the lowest increase since 1964. With inflation under control, we see little chance that the Fed will raise short-term rates anytime soon.

The slumping dollar, recently at a three-year low against the Japanese yen, could boost the inflation rate somewhat in coming months. That's because it will raise the cost of the goods we import and provide some cover for American manufacturers to increase prices. The good news is that it should improve earnings of U.S. corporations that export or have foreign operations. And higher earnings should ultimately be good for stocks.

We expect operating earnings on the S&P 500 to rise 17% to 53.76 this year. Based on our expectation of a yearend close at 1085, that's a price-to-earnings ratio of 20. S&P's chief investment strategist Sam Stovall notes that the 20 p-e is equal to the average since 1988. We see operating earnings increasing another 14% to 61.07 in 2004.

Even more impressive is the expected growth in S&P Core Earnings, which includes items such as options and pension expenses that companies tend to exclude in operating earnings. We see Core Earnings on the "500" increasing 78% this year and another 27% in 2004. In 2002, Core Earnings were only 51% of the index's operating earnings. That should rise to 78% this year and 87% in 2004, based on our current projections.

The closing of the gap between Core Earnings and operating earnings indicates to us that the quality and reporting of corporate profits are improving. That's another reason we think the market is heading higher.

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

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