'04 shaping up as good year for stocks, bonds

December 05, 2004|By Tom Petruno

Wall Street is hoping for a strong finish to a year that is turning out surprisingly well for financial markets.

Despite rising interest rates, a plummeting dollar, a sharp jump in energy prices and slowing corporate profit growth, Americans are on track to make good money this year in the bread-and-butter investment categories of stocks and bonds.

Things could always go wrong in December. But the calendar is on the side of the bulls: Investors typically have been an optimistic bunch in the last month of the year. The blue-chip Standard & Poor's 500 stock index has risen in nearly three-quarters of the Decembers since 1950, according to the Stock Trader's Almanac, which tracks market trends. The average December gain for the S&P: 1.6 percent, making it the second-best month of the year historically (after November, at 1.7 percent).

If stocks can hold on to decent gains in 2004, the market will have rewarded investors for two straight calendar years. That wouldn't erase the pain of the severe decline of 2000-2002, but it could bolster confidence that the market has moved on and that the risks of owning stocks don't drastically outweigh the potential rewards.

This year, the biggest surprise to many investment pros has been the breadth of the stock market's advance, meaning that people have found reasons to buy shares across an array of unrelated industries.

The average New York Stock Exchange issue has risen 9.4 percent as of the end of November. The average small-company stock has jumped 13.3 percent, as measured by the Russell 2000 index. Within the S&P 500 index, 85 stock industry sectors are in positive territory this year, while 28 have lost ground.

The average domestic stock mutual fund has gained 8.6 percent this year, according to research firm Morningstar Inc.

The story also has been unexpectedly good for bond mutual funds. Although the Federal Reserve has raised its benchmark short-term rate four times since June, to the current 2 percent, long-term interest rates have declined since then. That has reversed much of the damage done to the principal value of older fixed-rate bonds in the first half of the year, when long-term rates surged.

The average long-term bond fund has posted a total return (interest earnings plus or minus principal change) of 5.3 percent through the end of last month, according to Lipper Inc. Those returns stand out when compared with returns on cash accounts, such as money market mutual funds.

For some equity investors, this year has been so profitable that the question of what to do next - buy, sell or hold - has become much more difficult than it was, say, in June.

Do you stick with what's working but is perhaps now overpriced? Or do you buy stocks that have fallen, hoping for a bargain? Hot stock sectors always have a fundamentally good story underpinning them. But as the story becomes more widely known, and the stocks rise further, the danger is that the fundamental story takes a back seat to simple "momentum" investing: Many new buyers are jumping aboard simply to ride the rally as far as it goes, not because they are true believers in the industry's prospects.

Momentum investing can become a bigger factor in the market as the end of the year approaches, as professional portfolio managers seek to boost their returns by buying what's hot, hoping for a short-term gain.

The steel sector could be particularly vulnerable to a pile-on. The average steel stock in the S&P 500 has soared 64 percent this year. There's the fundamental story: Sales of steel are robust, in part because of heavy demand from China. That should give steelmakers greater pricing power and thus boost their earnings potential. Yet so far, Wall Street analysts are figuring that earnings at some steel companies will be lower in 2005 than in 2004. U.S. Steel Corp., for example, is expected to earn $6.65 a share in 2005, according to the average estimate of analysts surveyed by Thomson First Call. That is down from the 2004 estimate of $7.43 a share.

Why buy shares of a company whose earnings are headed lower? It may be that many investors believe analysts are underestimating the industry's earnings power. Or investors may be figuring that with U.S. Steel's share price at $51.25, even if the company earns $6.65 a share next year, the stock's price-to-earnings multiple of about 8 is a relative bargain.

Ditto for many transportation companies, which like steel firms have attracted a swarm of investors this year. Driven by railroad and trucking shares, the Dow transportation stock index is up 21.3 percent year to date.

Contrast that performance with what has happened to some of the classic growth stocks of the past decade. Shares of Coca-Cola Co., Merck & Co., Cisco Systems Inc. and other 1990s high-fliers have fallen sharply this year as investors have lost faith in their longer-term growth prospects. That's a big reason for the Dow Jones industrial average's poor showing.

Fans of those stocks say that if the shares aren't bargains yet, they're getting close.

Tom Petruno is a columnist for the Los Angeles Times, a Tribune Publishing newspaper.

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