Looking Beyond the Valley

History suggests that an anemic gain this year is likely to be followed by a more substantial advance in 2005, says S&P's The Outlook

By Joseph Lisanti

The market has advanced a bit over the past two weeks, but Standard & Poor's believes that it is unlikely to barrel ahead to a new high anytime soon. We expect the S&P 500 index to end 2004 at 1130, or only 1.6% above where it started the year.

If our projections are on target, this year's percentage gain would be one of the smallest in the history of the S&P 500. For investors burned by the 40% drop from the end of 1999 through 2002, any gain might be viewed as something to be grateful for. Nevertheless, a 1.6% rise pales against the 26.4% advance of 2003.

The potential good news in this otherwise boring market forecast is what this year's projected weakness may portend for 2005. Since 1928, the S&P 500 has ended the year up, but by less than 5%, only six times: in 1956, 1970, 1978, 1984, 1987, and 1992. In all but one case, the market posted a decent gain the following year. (The exception was in 1957 when the S&P 500 delivered a loss of 14.3%.) The six years following gains of less than 5% showed an average advance of 9.1%.

We are entering a traditionally weak period for stocks. The three months ending November historically have produced the worst stock market returns of any of the 12 rolling quarters. Over the past 76 years, the S&P 500 has averaged a 0.2% loss for these three months.

We suspect that the seasonal weakness is because some investors finally abandon the rosy scenarios with which they began the year. In the autumn of 2004, there will likely be numerous negative headlines to dampen investors' moods.

But it's human nature to be optimistic at the start of a new year. By then, some of the world's current problems may look more manageable. Or we may have become more acclimated to them. History suggests stocks will reflect that.

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

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