Add to Stock Holdings

With the advance in share prices likely to continue, S&P suggests moving 5% of assets from bonds to equities

By Joseph Lisanti

Although the final accounting of third-quarter corporate profits should show strong growth, investors already are assessing next year's prospects. As recent weakness despite good earnings reports shows, some still see the glass as half empty.

The majority of S&P 500 companies have reported their quarterly results, and Standard & Poor's estimates that final third-quarter operating earnings on the index will be up 23% from a year ago. Under more stringent generally accepted accounting principles, we see third-quarter earnings for the "500" gaining 38%. Using our proprietary S&P Core Earnings methodology, which includes the effects of option expenses, earnings in the latest quarter look to be 61% higher than they were in 2002's third period. Though we expect the torrid pace of the profit advance to slow, we still see good growth for the remainder of this year and next.

Those who see the glass as half empty contend that most of the profit growth is driven by cost cutting and the effects of the weaker dollar. As proof, they point to expected third-quarter growth in revenues for the "500"—an anemic 5.1%.

Without significant sales growth, profit gains will come from squeezing out costs. That's what is behind the rash of big merger announcements. But increased merger activity should also boost stocks as shareholders establish and maintain positions in the hope that their stocks will be acquired.

The revenue picture should start to look somewhat better in 2004 as consumers continue to buy and capital spending becomes stronger. And we believe that the quality of corporate earnings is improving as the spread between operating earnings and S&P Core Earnings narrows.

There will be bumps in the road, but we see the S&P 500 ending this year at 1085 and project 1190 by yearend 2004. In light of the upward move we foresee, Standard & Poor's now recommends an allocation of 65% stocks, 10% bonds and 25% cash.

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

    Before it's here, it's on the Bloomberg Terminal.