The Roller Coaster

The track has been bumpy so far, and we see this year's ride ending only slightly higher than it began

By Joseph Lisanti

The chart of the S&P 500 over the past seven months looks like a roller coaster. Every time the market appears ready to climb to a new yearly high, it turns and heads lower.

Corporate earnings growth has been the salve that has soothed the market for much of the year and kept it from hitting a new 2004 low. Despite persistent turmoil in the Middle East, terrorist threats, a toss-up U.S. presidential election, and high energy prices, investors had taken solace in strong corporate earnings. But earnings growth in coming quarters appears likely to be less robust than in the year-earlier periods. We think decelerating earnings growth has given investors pause.

Oil prices are not helping, either. Supplies remain so tight that any threat to the flow of crude, including the recent possibility that a Russian tax dispute would cut supplies, sends prices higher. We don't expect nervousness in the oil market to vanish quickly.

Investors are also mindful of the Federal Reserve's efforts to raise interest rates. Even though the Fed has made clear that it expects increases to be gradual, rising rates usually hurt stock returns. Sam Stovall, Standard & Poor's chief investment strategist, notes that the Fed has brought about multiple short-term rate hikes six times since 1970. On average, the S&P 500 stood 5% lower six months after the first rate increase.

On the positive side, stocks historically have gained in the fourth year of a president's term, earnings on the S&P 500 are at a record high, and stock valuations are more modest at current levels. But the negative background can't be ignored, and we believe that risk has increased.

Consequently, we have reduced our yearend 2004 target for the S&P 500 to 1150 from 1210. That still represents a modest 3.4% gain for the year. We advise 45% of investment assets in domestic stocks and 10% in foreign equities.

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

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