A Bumpy Road Ahead

S&P still thinks stocks will end the year a bit higher, but there are significant risks

By Joseph Lisanti

Last week, we reduced our recommended U.S. equities allocation to 40% of investment assets because of what we perceive as deteriorating economic and technical conditions.

We have also lowered our yearend target for the S&P 500 to 1130 from our previous estimate of 1150. Although that represents a projected gain of only 1.6% for calendar 2004, it is about 6% higher than the market's current level.

By now, more than a few of you are wondering how we can recommend only 40% in domestic stocks if we see the market gaining 6% in less than six months. The answer, in a word, is risk. While we see stocks ultimately up for the year, the path to that endpoint is rife with potholes.

The potential threats to stocks along the way to that expected 6% gain are all familiar: high oil prices, possible terrorist activity, rising interest rates, slowing corporate profits, weaker-than-expected U.S. job creation, continued turmoil in Iraq, and a presidential election that remains too close to call.

We have been publishing asset allocations since 1988. And, though 40% in domestic stocks is a low allocation by historical standards, it should be considered in context. We only began breaking out a foreign stock recommendation in February of this year. Before that, the allocation choices were simply stocks, bonds, and cash. If you add our foreign and domestic stock allotments, you'll see that we still advise 50% of assets in equities. Our record low stock allocation recommendation was 45%.

The big difference now is that our cash recommendation is at 40%, an all-time high. That's because, with interest rates rising from 45-year lows, we don't advise a large bond position. We suggest that any bonds you own be short-to-intermediate term, and that you plan to hold to maturity.

At the time we advised 45% in equities, our bond position was a more typical 30%. Today, it's 10%. We think caution is prudent.

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

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