Forecasters see room for stock market to grow

Martin Wolk Chief economics correspondent • Profile • E-mail

After a surprising rally that propelled the stock market's best-known indicator to record levels in 2006, analysts are looking for a less spectacular but still solid year in 2007.

Although the economy is slowing substantially and there are signs that inflation is heating up, the vast majority of forecasters are looking for a "soft landing" scenario that should lead to continued growth and a rising stock market, if not the double-digit returns of the past five months.

"I would use the expression single-digit," said Hugh Johnson, chairman of Johnson Illington Advisors.

"I'm looking for single-digit growth in profits and a single-digit rise in the stock market," he said. "We're late in the cycle, and the economy is slowing and earnings should slow, which is very symptomatic of the late stages of the cycle. The stock market should reflect that by going up at a much more sluggish rate."

Sam Stovall, chief investment strategist for S&P Equity Research, agreed, saying the market is likely to grow solidly but well under the 14 percent return seen for the year to date. For next year, he is projecting the Standard & Poor's 500, a broad measure of big-company stocks, will rise about 8 percent.

"We still think it's going to be pretty good," he said.

Things looked a lot different just a few months ago.

As recently as mid-July, it seemed like another ho-hum year for Wall Street – or worse. As a war raged in Lebanon and tensions rose over Iran's nuclear ambitions, gas and oil prices soared to record levels. The wheels were coming off the housing market, and the economy was slowing after a post-Katrina growth spurt.

As late as July 18, the stock market was in negative territory for the year.

Then Federal Reserve Chairman Ben Bernanke, in office less than six months and still working through a somewhat  uneasy relationship with financial markets, fired the starting gun for a stock market rally that turned out to have surprising legs.

In testimony to Congress that month, Bernanke said rising inflation was a concern but  the central bank also was worried about raising rates too high and squeezing the economy. The comments were seen as a signal that central bankers were close to the end of a cycle in which they raised interest rates 17 straight times over two years.

As it turned out, the Fed already had moved the sidelines. The central bank has not raised rates since June 29, and many analysts think the next move may be to cut rates sometime next year to stimulate the slow-growing economy.

The more favorable rate environment is far from the only factor behind the stock market's vigorous rally. Some other developments have been at work:

• Strong corporate profits. Even though the economy has been growing only modestly, corporate profits have been going gangbusters, rising at double-digit rates as industries ranging from airlines to telecommunications have reaped the benefits of aggressive cost-cutting.
• Falling oil prices. Crude oil has fallen from a high of about $79 a barrel in midsummer to well under $65, and prices for refined products have fallen as well. That has cut costs for industry and put cash back into consumer pockets.
• Reduced geopolitical tensions. Even though the United States and its allies remain mired in the war in Iraq, tensions over Iran have eased slightly, and North Korea recently returned to six-party negotiations.
• A world awash in cash. Many analysts point to the huge amount of "liquidity" or cash on the balance sheets of individuals and corporations here and abroad, all seeking a home in financial markets. Private hedge funds backed by wealthy individuals and foundations have poured money into the stock market and are behind some of the year's biggest corporate acquisitions, including the $21.3 billion purchase of hospital chain HCA Inc.

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