Bucking the Odds?

S&P believes strong corporate profits and continued low long-term interest rates will allow stocks to end 2005 slightly higher

By Joseph Lisanti

The S&P 500 rose 3% in May for its best monthly showing of 2005. Yet through May 31, the "500" was 1.7% below where it started the year. Can it push into positive territory by December 31? History suggests otherwise, but we think it can.

Over the past 75 years, the index has finished the month of May in negative territory 29 times. In 20 of those cases, or 69% of the time, it ended the year with a loss. Recent numbers are even bleaker. From 1985 through last year, the "500" showed a loss at the end of May on five occasions. In 80% of those cases, the full year ended down.

So why do we believe the market will end 2005 slightly higher? One reason is strong corporate profits. Although we expect the rate of earnings growth to decelerate, we still look for the "500" to post record operating results of 75.25 this year and 82.82 in 2006.

The other reason is interest rates, which we believe are likely to remain low by historical standards. Despite eight consecutive increases in the fed funds rate (what banks charge each other for overnight loans), the 10-year Treasury note yields less now than when the increases started.

Thank the kindness of foreigners, or more accurately, their self-interest. Asian central banks, particularly China's, have been buying our debt to prop up the dollar so that we can continue buying their goods. Add to that purchases by individuals whose home countries' notes carry even lower yields than ours.

With the world awash in cash, much is finding its way into U.S. Treasury securities. As a result, Standard & Poor's economists now expect the 10-year T-note to yield 4.75% at yearend, down from our previous forecast of 5%. Because lower Treasury yields provide less competition for investor dollars, we have raised our yearend target for the S&P 500. We now see 1,255, up from 1,245.

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

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