A Correction in the Cards?

The stock market is likely to continue its advance, but history suggests that a pullback is possible

By Joseph Lisanti

So far, 2004 has been good for the stock market. To some investors, conditions look right for a sustained advance. With the economy on the mend, that appears to be a logical conclusion.

The U.S. today has economic growth high enough to avoid recession, yet low enough to keep inflation in check. We estimate that real growth in gross domestic product should equal or surpass 4% in coming quarters. Though not as exciting as the 8.2% surge in GDP in the third quarter of 2003, it is, nonetheless, solid.

Corporate profits that now are being reported for the fourth quarter of 2003 appear likely to exceed analysts' expectations. Interest rates remain low, and given the recent weak payroll numbers and negligible inflation, Standard & Poor's economists do not expect a rate boost by the Fed until later this year. Consumers appear willing to spend, and expected larger tax refunds in 2004 should help keep the malls busy.

All of the data paint a picture that looks ideal for a continued market advance. But markets often upset the complacent. Mark Arbeter, S&P's chief technical analyst, notes that numerous short- and intermediate-term market tops have appeared in January. Seven of them have occurred since the beginning of 1990, including one each year since 2000. Peaks took place in February in 1994 and 1997. Furthermore, says Arbeter, stocks entered a trading range early in the year on four other occasions since 1990. Taken all together, the early year peaks and trading ranges have occurred in 13 of the last 14 years.

As long-term market participants know, stocks seldom climb straight up without a pause. This year should be no exception. A 5% to 10% correction could occur at any time.

After that, however, we see the market continuing its advance. Overall, we now expect a full year gain of 11% in the S&P 500 and have raised our yearend target to 1,230 from 1,190.

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

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