The bulls are pawing and snorting

By Mara Der Hovanesian

updated 5:57 p.m. ET Dec. 19, 2005

Market bulls are itching to run. They say U.S. stock indexes will not only hit a new high over the next 12 months but also will break their all-time record of five years ago, the peak of the longest-running bull market in history. U.S. business, the bulls argue, will clock in its fourth straight year of strong profit growth, and the economy will grow at a robust clip of 3 percent or more. Oil prices that reached $70 a barrel this summer will ebb, and inflation worrywarts will be silenced, at least for now. Oh, and the bottom won't fall out of the housing market, either.

Sound far-fetched? Maybe it isn't. If the woes of the auto and airline industries, a Category 4 hurricane, surging oil prices, and increasingly indebted consumers haven't yet derailed the markets, what on earth will? Even a dozen Federal Reserve interest rate hikes since mid-2004 haven't put the kibosh on the economy, which grew at a stronger-than-expected 4.3 percent rate in the third quarter. Sure, the markets have struggled to process often conflicting signals and, as a result, have been stuck in a narrow trading band for two years. So how can the bulls be so sanguine? "Everyone complains about the stock market going sideways, but sideways is in fact an incredible victory," says Ronald P. O'Hanley, vice-chairman of Pittsburgh-based Mellon Financial Corp.

Optimists aplenty
Good point. Thanks to the recent rally, the Standard & Poor's 500-stock index and the Nasdaq Composite Index were up 4 percent and 3.7 percent, respectively, through Dec. 9, although the momentum was barely enough to push the Dow Jones industrials into positive territory. Yet even that lackluster outcome is seen as a harbinger of good returns. With the S&P trading at a price-earnings ratio of about 16 based on estimated 2006 earnings, many investment pros think the market is undervalued. "We're bullish," says David S. Spika, an investment strategist at Westwood Holdings Group in Dallas. "The market is relatively cheap."

Spika has plenty of company among the Wall Street strategists we polled for BusinessWeek's 34th yearend investment outlook. The consensus pegs the Dow closing above 11,500 next year, the S&P at 1,347, and the Nasdaq Composite at 2,428 — roughly 7 percent gains from here. Our forecasters say they're optimistic because two major headwinds for equities — rate hikes and oil price spikes — look to be easing off.

As always, an important driver in the stock market will be profits, and they're still holding up well, too. By yearend, S&P 500 stocks will have reported about $77 in operating earnings per share — a 13 percent rise, and the 15th quarter in a row of year-over-year double-digit growth. Howard Silverblatt, an equity-market analyst at S&P, says his group expects an additional 11.4 percent increase in 2006. "It'll downshift just a little bit," agrees Bob Baur, managing director, Principal Global Investors LLC. "But there's nothing wrong with that. You can't expect 20 percent profit growth forever."

Companies have been sharing that wealth. In 2005 they spent a record $300 billion on share buybacks and another $200 billion on dividend payments, according to Silverblatt. That trend is expected to stay intact, so dividend-paying stocks are still a good bet.

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