S&P's "Outlook"

01/06/2006 12:00 am EST

Focus:

Stephen Biggar

Director, Product Strategy, Argus Research Corporation

When it comes to quality, integrity, and long-standing successful investment advice, few on Wall Street compete with Standard & Poor's. Here, in The Outlook, equity analyst Stephen Biggar looks at the firm's favorite industriesand stock picksfor the coming year.

"For 2006, we see the S&P 500’s total return at 8.5% as the economy and corporate profits continue strong. Specifically, our economists expect the real gross domestic product in the US to increase 3.4% in 2006. We see inflation, measured by the CPI, remaining muted at 2.4%. We think the projected $200 billion likely to be spent on rebuilding efforts in the wake of Hurricane Katrina will contribute to growth in the first half of 2006. Corporate profits should continue to rise, albeit at a somewhat slower pace next year.

"For next year, we project S&P 500 dividends will total 24.50, a 10.9% advance. Cash on the balance sheets of non-financial companies in the S&P 500 hit another record in November, at $638 billion. This has enabled companies to increase their share buyback programs. Over the 12 months ended September 30, 61 issues in the S&P 500 have lowered their share count by at least 4%. We think this has positive implications for per-share earnings and, therefore, stock prices.

"In our view, the S&P 500 is attractive at a current multiple of 16.5 times our estimate of 2005 operating earnings. That compares favorably with the 19.8 average P/E ratio on estimated operating earnings for the period 1988 through 2004. In addition, relative to bond yields, the current 6% earnings yield of the index (the inverse of the P/E) suggests to us that the market is undervalued, and we think it is an appropriate time to consider higher-quality stocks.  We recommend that you keep 45% of your investment assets in domestic stocks, 20% in foreign equities, 20% in short-to-intermediate-term debt instruments, and 15% in cash.

"We believe that the fashion trend for career wear and dressy attire should boost consumer spending on apparel and accessories. Also, we are seeing renewed strength in men’s apparel. A market bifurcation c ontinues, in our view, with consumers opting for either luxury brands or low-cost items. We expect apparel companies to continue to improve sourcing and efficiencies, broaden offerings, and target new markets with acquisitions, licensing, and brand extensions. Our top pick is Coach (COH NYSE), and we also recommend Liz Claiborne (LIZ NYSE) and Polo Ralph Lauren (RL NYSE).

"We project strong quarterly earnings for the biotechnology industry through 2006 and a steady stream of new product and supplemental approvals. We also believe that the valuations of biotech stocks are appropriate in light of the industry’s growth prospects. In our view, sales gains and new products should help the group, and we look for industry-wide share price gains of about 20% over the next 12 months. We expect cancer therapeutic sales and development to remain the primary stimulus for the sector’s growth. We also believe the prospects for autoimmune and inflammatory therapeutics should remain solid. Our top picks are Amgen (AMGN NASDAQ), Genzyme (GENZ NASDAQ), and Renovis (RNVS NASDAQ)

"In our view, a number of data processors offer an attractive combination of growth, value, and quality. We think these stocks also provide an opportunity to participate in the potential upside of technology stocks without the higher levels of risk normally associated with unproven business models and premium valuations. Two significant trends that we see are the growth of outsourcing and the continuing prevalence of electronic transactions. We believe corporations are increasingly outsourcing technology tasks to third parties in order to achieve greater efficiencies and profitability. We have strong buy ratings on Automatic Data Processing (ADP NYSE) and Fiserv (FISV NASDAQ)

"We believe commercial loan demand has been strengthening among small businesses and middle markets in recent quarters, and we think this is likely to extend to the large corporate market in 2006. Loan demand from big corporations has remained below long-term trends in recent years, as companies relied mainly on internally generated capital and debt issuance to finance their needs. We continue to favor banks with diverse revenue streams because we believe they should have an easier time posting per-share earnings growth in a variety of economic environments. We strongly advise purchase of Bank of America (BAC NYSE), and also favor Comerica (CMA NYSE) and US Bancorp (USB NYSE).

"We expect education demand to remain solid even in good economic times as many workers go back to school to enhance their skills. Given that only about one-third of working adults have associate degrees or better, we think business will remain favorable in the long term for education companies. Allegations of dishonest behavior at a few for-profits reduced valuations in the past year, but we note that several firms have been cleared of charges. Overall, we think certain for-profit educators are good investments, though we believe the industry carries high risk. We strongly advise purchase of Apollo Group (APOL NASDAQ) and also like DeVry (DV NYSE).

"We believe the strong gains so far this year in managed health care partly reflect continued investor expectations of healthy per-share earnings growth through 2006. We also see investor optimism about a stronger economy, improved prospects for Medicare managed care programs, and possibly more industry consolidation. In addition, we think investor concerns over state investigations of health insurers have mostly faded. Our favorites in this group are Aetna (AET NYSE), UnitedHealth Group (UNH NYSE), and WellPoint (WLP NYSE).

"Over the longer term, we expect demand for contract drilling to increase.  The deepwater and mid-water semi-submersible markets continue to improve . In the Gulf of Mexico, we expect an uptick in day rates, based mainly on tight supply following hurricanes Katrina and Rita. Day Internationally, supply-demand fundamentals appear strong to us in West Africa, Southeast Asia, and the North Sea . Internationally, we expect additional spending by major oil concerns to be the main stimulus for drilling, as they continue to search for low-cost opportunities, mainly in new regions. We highly recommend Global-SantaFe (GSF NYSE) and Nabors Industries (NBR NYSE)."

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