Weakness Looks Temporary

Compared with last year's returns, stock market gains have been puny in 2004. S&P sees improvement in the months ahead

By Joseph Lisanti

In the first five months of 2004, the S&P 500 gained 0.8% vs. a 9.5% advance in the same period last year. And, as might be expected, fewer stocks rose. At the end of May last year, 396 stocks in the index had posted advances for the year. This year, only 274 were up. In fact, market breadth (the percentage of stocks participating in a rally) is closer to what it was in first five months of the bear market years of 2000 through 2002.

A closer look at the data reveals that January and February of this year saw more stocks advancing than in the first two months of 2003. The slowdown began in March and became worse in April. And even though May's index results were positive, only 59% of S&P 500 stocks rose last month, vs. 88% in May, 2003.

We attribute the downturn in March and April to the growing likelihood of an interest rate hike, the continuing instability in Iraq, and fears of increased terrorism. In our opinion, the addition of 248,000 jobs to the country's nonfarm payroll in May reinforces the case for higher short-term rates when the Fed meets at the end of this month. Nevertheless, stocks rose following the release of the latest jobs figures. That could mean investors consider the payroll report "Goldilocks" data: not too hot (the Fed would have to raise rates aggressively), not too cold (the recovery would be in danger), but just right.

If investors continue to view the Fed's expected actions in this way, that could remove one major impediment to the market's renewed advance. We still are concerned about factors outside the economy that could affect market psychology, particularly Iraq, potential terrorism, and the uncertainty caused by a dead heat in the run for the presidency.

Assuming no major external shocks, the economy and the stock market appear likely to do well in the coming months.

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

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