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How long can this bull run?

It's easy for market soothsayers to see factors that show great promise, and just as easy to find gloomy omens. Then there is the array of unknowns.

By HELEN HUNTLEY
Published January 2, 2005

Just how healthy is that stock market bull?

Since stocks bottomed out in March 2003, investors who held on for the bumpy ride have been richly rewarded. The Standard & Poor's 500 Index is up about 50 percent, while the Nasdaq Composite Index has risen a whopping 70 percent.

The blue chip indicators even have moved within striking distance of the peaks they hit in 2000; a gain of just 10 percent or less would take both the S&P and the Dow Jones Industrial Average to new highs. However, the Nasdaq, the measuring stick for the tech stock boom and bust, would have to more than double to get there.

So what's likely to happen in 2005?

"I'm looking for a good year, but it might not be quite as good as 2004," said Daniel Morgan, a portfolio manager for Synovus Investment Advisers in St. Petersburg. Like many other investment professionals, he is optimistic but cautious. "The equity market should continue to do well, but in the back of your mind you have to think about interest rates and oil prices and the influence they could have in terms of corporate profits and consumer demand."

Market predictions rest on economic forecasts with a little political, psychological and technical analysis thrown into the pot. Stock prices ultimately depend on corporate earnings and on what investors are willing to pay for those earnings, which can vary widely.

Most economic signs are positive for stocks.

"Our sense is that the economy is going to grow at roughly 3.5 percent a year, which is a decent rate of growth," said Bill Seiffert, senior vice president of Northern Trust Bank of Florida in Tampa. "Inflation should remain relatively benign, around 2 to 2.5 percent. Even if interest rates do move up to 3.5 to 4.5 percent, by historical standards that's eminently reasonable and certainly not anything that would derail an economy."

Standard & Poor's Corp. forecasts an 8.3 percent gain for stocks this year, based primarily on gains in corporate earnings. Investors are paying about 21 times earnings per share for stocks in the 500 index and S&P doesn't think that number is likely to go up much. The company predicts operating earnings for companies in its index will grow 10.4 percent this year, half last year's 22.5 percent gain.

The good news is earnings were so strong in 2003 and 2004 that companies have a lot of cash they have not spent. Clearwater financial planner Ray Ferrara at ProVise Management Group says that excess cash has the potential to stimulate the stock market this year:

"They're going to either follow Microsoft's lead and pay that out, perhaps as extraordinary dividends to the shareholders, or they're going to have to buy companies or merge companies with that cash and put it to work. Or perhaps they will go back to spending, modernizing and building up their facilities. I see all that cash in the corporate coffers as a very strong sign going into the first six months of the year."

Corporations also might spend some of that money on hiring, which would give consumers more money to spend. In December the Federal Reserve reported labor market conditions continue to improve gradually.

However, major question marks remain.

Conventional wisdom is that rising interest rates are bad for stocks, and absent some traumatic event, short-term rates are likely to move higher. The Federal Reserve Board is on a steady course of racheting up the federal funds rate, the rate at which banks lend each other money overnight. Now at 2.25 percent, it could easily be 3.5 percent or higher by year's end. Essentially the Fed is taking away the ultralow rates it used to stimulate a weaker economy to return to more normal levels.

Higher short-term rates are good news for savers, who should see better returns on money market funds and CDs, but bad news for borrowers, who will pay more interest on their credit cards and other loans.

What's tough to predict is what will happen to long-term interest rates as the Fed tightens. Strong domestic and foreign demand for U.S. Treasury securities has kept those rates low, but any change in that supply-demand equation could have costly consequences.

Higher mortgage rates would put a crimp in the real-estate boom and higher bond rates would make the budget deficit worse. Investors would get better rates when they bought new bonds, but bonds they owned would decline in value.

Some advisers are recommending that clients stay away from long-term bonds to avoid the risk of losing money to rising rates.

Many investors also worry about the twin deficits - the federal budget deficit and the current account deficit, which is the result of the American appetite for foreign goods and the foreign appetite for U.S. investments, including our government bonds. Many people are concerned that the declining dollar eventually will discourage foreign investment in the United States.

"If foreign central banks weren't buying Treasury securities, our long-term rates would be higher already," said Scott Brown, economist for Raymond James & Associates in St. Petersburg. "Foreigners don't have to pull money out for the dollar to go down; they just have to start putting less in. It's not too hard to spin a scenario in which things start to unravel, although I don't think any of that is likely at this point."

Oil prices also remain a drag on economic growth even though they have retreated from their highs.

A lot of cash remains on the sidelines as investors try to figure out what to do with their money. Investor confidence has improved the past two months, but is substantially below levels of the late 1990s and 2000, according to a monthly survey conducted by UBS and the Gallup Organization.

"People are still skeptical of the stock market after being burned in the big bear market," said St. Petersburg money manager Timothy McIntosh of Strategic Investment Partners. "Another positive year would really help investors feel more confident they can place assets in equities."

His forecast is decidedly upbeat; he expects stocks to return 20 percent in 2005.

Some investors share his optimistic outlook. Retiree John McBaine of Indian Shores says he is confident about the future.

"I love the prospect of historic investment and tax code legislation from the Bush administration aimed at reducing government control over personal savings and investment," he said. He predicts this "will launch the market back up to its previous highs and beyond over the next few years."

But others are frankly worried.

"I feel our economy is built like a house of cards ready to fall at any given moment," said Brooksville retiree Robert Kilgore, who said he is pulling his money out of stocks. "If Greenspan and the Bush administration do nothing to bring back value to the greenback, we will be in a terrible fix. This, along with our unprecedented spending on a war that will never end, will cause all foreign investors to redeem their Treasury holdings."

In addition to a currency or debt crisis, pivotal moments in the war in Iraq or the fight against terrorism or surprises no one anticipates have the potential to influence the markets this year for good or for bad.

Clearwater money manager Grady Garrett of LBS Capital Management is looking for surprises that could propel the market upward, such as Osama Bin Laden's capture or a smoothly run election in Iraq.

St. Petersburg investor Bryan Marks is concerned that more questionable practices by mutual fund managers will come to light.

Others plan to stick with a steady allocation to stocks and bonds regardless of economic conditions and events.

"I am a passive, globally diversified investor so I will earn what the global stock markets are willing to give," said St. Petersburg investor Adrian Nenu.

Largo investor Robert Wells says "there are, in my opinion, no rational alternatives to the market as a whole, so why worry?"

One way to approach the market is to try to figure out which sectors of the market will outperform, then buy stocks or mutual funds that specialize in those areas. Members of the National Association of Investors Corp. say real estate, pharmaceuticals and technology are their favorites for the new year.

Synovus money manager Morgan said he expects industrial and energy stocks to do well, along with companies targeting consumer necessities such as food producers and grocery stores. Money manager McIntosh is high on some of the big pharmaceuticals, semiconductors, household products and foreign banks.

Banks, builders and developers could be a good bet if interest rates stay low, said St. Pete Beach investor John Hamilton. However, the possibility of higher rates makes other investors wary of those sectors.

Clearwater financial adviser Ferrara likes stocks that will benefit from military and antiterrorism spending.

"Given a choice between being wealthy or secure, most people will choose being secure," he said.

Raymond James economist Brown sees good prospects for the hospitality industry, both restaurants and lodging.

"The softer dollar should help tourism quite a bit," he said. "It brings foreign tourists here and makes U.S. residents less likely to go abroad."

Making sector bets is riskier than holding a fund that tracks the performance of the market as a whole. Last year higher oil prices made energy stocks winners, while problems in the pharmaceutical industry dragged down health-care stocks.

The only sure bet for 2005 is that the markets will be volatile. Unless, of course, they turn out to be surprisingly calm.

Helen Huntley can be reached at 727 893-8230 or huntley@sptimes.com

Economic growth is expected to continue, bolstering investor confidence, which is lagging despite back-to-back good years for stocks. Strong earnings over the past two years have given companies lots of cash, which they could spend on dividends, equipment or new hires, all good options for the market.

Any threats to economic growth will be felt in the markets. Long-term interest rates, which have been insulated by hikes in short-term rates, could creep higher. Oil prices could rise again, events in Iraq could rattle investor confidence or the falling dollar could trigger a currency crisis.

[Last modified January 1, 2005, 23:54:13]