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Stovall: History Is On the Markets’ Side

02/16/2007 12:00 am EST


Sam Stovall

Chief Investment Strategist, CFRA Research

Standard & Poor's chief investment strategist, Sam Stovall , sees some historical and fundamental tailwinds that will push US stocks higher this year, but he picks two international stocks that he thinks will mean many happy returns for investors...

Sam Stovall's 2007 Predictions:

2007 High 2007 Low 2007 Close
Dow Jones Industrial Average 14,000 11,900 13,270
Standard & Poor's 500 1,600 1,350 1,510


Favorite International Stocks for 2007:
AU Optronics (AUO)
Bayer (BAY )

From the "Name That Stock" Lunch Panel at The World Money Show Orlando 2007

There are [several] things from history that say this could be a good year. First we are in the fifth year of a bull market. There have been six times that a bull market has celebrated its fourth birthday and entered into its fifth since World War II. Of those six, four of them have celebrated their fifth birthday. So, history says we have a two in three chance of completing this year with an average gain of close to 9%.

We're also in the third year of a presidential cycle. The market has never declined since World War II in the third year of a presidential cycle. The average advance is twice that of the average gain.

And then lastly, lower interest rates. Should the Fed begin to lower interest rates, history says we end up getting 12 months' worth of returns in six months.

Do we think from a fundamental standpoint those things might actually come true? [Yes.] Even though we saw a 15% increase in operating earnings in 2006, we're probably going to see a 9% increase in 2007. Six times out of every ten, the market has continued to rise 12 months later even in a decelerating corporate earnings environment.

Also, this is the only bull market I've seen since the 1940s in which we've actually experienced contraction [in the price/earnings ratio] every year this bull market has aged. So, right now we're actually trading at a 15% discount to the average P/E ratio since operating earnings were first captured in 1988. So, from a valuation standpoint it looks as if we're not stretched at all.

From an economic standpoint, we embrace a "soft landing" approach. Our feeling is we're probably going to see a 2.6% gain in real GDP this year, probably an even stronger advance in 2008. We think oil prices will remain stable in the $60 to $65 per barrel area, we think inflation probably will remain around 2.5% and if you use the old rule of thumb--that if you take inflation [and add 2%], that's a neutral fed funds policy.

At 5.25% we're about 75 basis points higher than we should be, so we still believe the Fed is likely to lower rates starting in the fourth quarter of this year.

[Our favorite stocks] are ADRs that have five-star ratings by S&P analysts and they are diversified by sector.

AU Optronics (AUO) is from Taiwan; it's a global supplier of LCDs used in laptops, televisions, computer consoles etc. 2007 sales are seen rising 36%, the same as last year, [while] earnings are expected to grow 52% this year [and] 47% in 2008. It is sort of a high-risk stock [as there are] concerns for the cyclical nature of this LCD panel industry.

Bayer (BAY) is a German-based diversified global chemicals company with pharmaceuticals and consumer product activities. Our feeling is [it has a] strong balance sheet and a good business mix with global exposure. Recently it acquired Schering AG, it's looking to strengthen its health care business and it offers a modest yield at 1.7%.

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