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On Tap for Stocks: A Strong 2007

Earnings are terrific, but stock prices are stalled. S&P's chief strategist says the stalemate will end in your favor.

Sam Stovall has been the chief investment strategist for Standard Poor's since 2001.

Shouldn't stocks be doing better this year? Compared with last year, profits are much stronger than you and other analysts predicted. True, we did not think earnings growth would be accelerating in 2006, but rather decelerating. But we're about four years into this bull market. The average bull market lasts four and a half years. The third year tends to be the most disappointing. There comes a point, after all, at which the rate of earnings growth just has to slow down. Investors may be worried it's the end.

Does that mean stocks will fall apart next summer? No. Six out of ten times the market is up 12 months after the rate of earnings growth peaks. And if the final year of a bull market is coming up, that's usually one of the best times. Stocks rise by an average of 14% during that time. The only better year is the first, when the average gain is 38%.

Why have earnings been so strong this year as the economy has begun to slow? One reason is that companies are very good at managing expectations for their earnings. Energy efficiency has a major impact. And although we did have more than four percentage points of interest-rate increases, rates are still modest. Remember that profit margins are at record levels.


What's your outlook for the rest of 2006 and for next year? I think stocks will be more volatile in the next few months. We've not had a correction of 10% or more in this whole bull market. We are due. But a correction like that will make it easier for me to forecast a strong advance in 2007. The three strongest quarters for stocks in any presidential cycle include the midterm election quarter and the next two in the following year. And stocks are inexpensive on a historical basis. The SP 500 is trading at a 20% discount to its average since 1988 on operating results -- that's earnings before accounting stuff -- and 25% if you go by generally accepted accounting principles.