Industrials have been my favorite sector for the fourth quarter of this year; my latest recommendati...
04/21/2006 12:00 am EST
When it comes to quality and integrity, few groups on Wall Street match Standard & Poor's. Reflective of this industry-leading reputation is chief investment strategist Sam Stovall, who offers his outlook for the markets in the firm's weekly publication, The Outlook.
"The first-quarter earnings reporting season is beginning in earnest. By comparing S&P equity analysts' estimates on December 31, 2005 with those as of April 4, 2006, we believe operating earnings for the companies in the S&P 500 will have increased 11%, spurred by above-market gains for the energy, health care, and industrial sectors. Financials, information technology, telecom services, and utilities are expected to post below-market gains, while the consumer staples and materials sectors are likely to report year-over-year declines in earnings.
"Even though S&P equity analysts expect the S&P 500 to post its 16th consecutive double-digit increase in year-over-year operating earnings during the first quarter, the gap between success and failure has narrowed since the end of last year, when we forecast a 13% advance in first-quarter results.
"Projections for the first quarter are also lower for eight of the 10 sectors in the S&P 500, with the outlook for the consumer staples sector slipping into negative territory. Only our estimate for companies in the financials sector has improved, albeit modestly.
"Over the course of the first quarter, full year 2006 forecasts for seven sectors also have been trending lower. We believe higher interest rates and elevated oil prices, along with a strengthening of the US dollar over the past year and more modest increases in consumer spending, are likely to be the stated reasons for the more moderate results.
"Even though our equity analysts' full year forecast of operating earnings for the S&P 500 has held fairly steady (now a 10% gain is estimated vs. an earlier 11% projection), the small-cap story is a bit different. We initially expected to see a 19% increase in earnings for the S&P SmallCap 600 index in 2006. Now, however, we predict a 17% advance. What's more, small-cap stocks may be getting pricey, in our opinion, as they sport an average P/E ratio of 18.2 vs. 15.4 for large caps, based on these reduced 2006 estimated earnings.
"Is it time to pull the plug? Not just yet, in our opinion. S&P's Investment Policy Committee continues to project a 1360 year end 2006 price level for the S&P 500. We believe this 9% price appreciation will likely be achieved by healthy economic growth, an end to the Fed's rate-tightening program at mid-year, a resulting renewed weakening in the US dollar (which could aid exports), and an eventual moderation of energy prices.
"The valuation of the S&P 500 remains attractive, in our view. At 16.3 times trailing 12-month operating earnings, it is 17% below the average trailing P/E of 19.7 since 1988, when S&P first began tracking operating results. Even without a P/E expansion between now and the end of the year, 84.34 in projected per-share earnings for the S&P 500 would translate into a yearend price of 1375. We therefore recommend staying the course with equities."
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