Good Earnings Power Stocks Higher

05/02/2007 12:00 am EST

Focus: MARKETS

Daniel Wiener

Editor, The Independent Adviser for Vanguard Investors

Dan Wiener, editor of The Independent Adviser for Vanguard Investors, says better-than-expected earnings continue to power stocks higher, although big blue chips still haven't outpaced small caps.

Expectations for first-quarter profits had been nothing less than abysmal, yet as the early reports from about half of the companies in the Standard & Poor's 500 showed, diversified busi­nesses with operations here and abroad were able to handle the new year's economic and housing storms well.

The rest of the S&P companies will report in over the next couple of weeks, changing the picture. However, it looks like earnings growth could come in at a high single-digit rate. While that's not the double digits we've become accustomed to, it's not no-growth, either.

That means there's a reasonable chance that the markets, which hit numerous highs in April, could continue higher. Employment remains very strong. The global economy is growing smartly. Yes, profit margins are being squeezed. However, tightening of profit margins doesn't necessarily lead to a decline in the stock market or an end to the bull. Take a look at the late 1990s: Profit margins hit their peak in the second half of 1997, yet stock prices kept moving higher until topping out in early 2000.

Back to those records for a moment. The Dow Jones Industrial Average cruised past the 13,000 mark in April, completing the 8.3% rise necessary after hitting 12,000. Mid-caps continue to lead the pack, and the S&P 400 MidCap index hit a series of highs, ending April up 8.6% for the year versus a year-to-date gain of 4.8% for the Dow index and a 4.5% rise for the S&P 500 index.

Vanguard Health Care fund (VGHCX, closed to new investors) revived nicely, up 5.6% as the sector came into favor once again on the backs of some pretty good profit reports. All the talk of universal health coverage by presi­dential aspirants hasn't dulled the fact that this sector remains one of the best long-term investments we can make.

Large-cap stocks took one from the mid-caps and small-caps in April. History says that slowing economies are good for corpo­rate behemoths at home. However, the global economy is still running strong and favors many more companies than it did in the past-large and small. We don't need to alter our portfolios now.

It's been a long period of outperformance by domes­tic mid-cap and small-cap stocks, and while the line is flattening, indicating more even performance on a month-to-month basis, there's no evidence the big boys are eating the smaller ones' lunches just yet.

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