Better Times Ahead?

Despite higher short-term interest rates, S&P thinks conditions are favorable for stocks in the coming months

By Joseph Lisanti

The Federal Reserve raised its fed funds target to 3.75% at the Sept. 20 meeting. We now expect the Fed to continue its "measured" pace of tightening by 25 basis points (one quarter of a percentage point) at each of its two remaining 2005 meetings.

"If Katrina didn't stop the Fed, nothing will," observes David Wyss, Standard & Poor's chief economist. He now believes that a rate increase also is likely at the January meeting, which would bring fed funds to 4.5%.

The statement issued with the Fed's most recent increase noted that Hurricane Katrina's disruptions "do not pose a more persistent threat." But the Fed noted that the boost in energy costs has "the potential to add to inflation pressures." We take that to mean that the Fed is now a bit more concerned that the latest energy shock will fuel inflation.

Our projection for the 2006 average gain in the core consumer price index, which excludes food and energy, remains a moderate 2.4%. While we don't see much in the way of inflation, neither do we see the economy slowing considerably. Standard & Poor's analysts now expect S&P 500 operating earnings to increase 10% in 2006. Although that's down from the 14% growth we project for this year, it is still a fairly robust advance.

The market's seasonal patterns appear favorable. Although October is known for its crashes in 1929 and 1987, stocks usually do well during the month. Since 1990, the average October gain for the S&P 500 has been 2.4%.

Sam Stovall, Standard & Poor's chief investment strategist, notes that the fourth quarter has been positive for the S&P 500 in 13 of the 15 years since 1990. What's more, Stovall notes that consumer discretionary and tech stocks, the two sectors we currently favor, tend to outperform the market during the quarter.

A strong market with good showings by tech and consumer stocks could put investors in a merry mood by the end of 2005.

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

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