In Only Five Months, Stocks Had a Good Year
It's not even the halfway point of 2007, yet the stock market has already delivered gains that would be respectable for a full calendar year. The Dow Jones industrial average was up 9.3 percent through May. That's about what stocks have typically delivered in an average year over the past century.
And it's not just the Dow. The Standard & Poor's 400 index of mid-capitalization stocks has turned in the best performance so far, posting gains of nearly 14 percent through the end of May. The better-known S&P 500 index of large-cap stocks was up 7.9 percent. And even the Nasdaq composite index, the only major market index not trading at record highs, jumped 7.8 percent.
"The U.S. equity market has performed better than most investors expected heading into the year, with mid-caps showing the most powerful returns," says Tobias Levkovich, chief U.S. equity strategist for Citigroup Investment Research.
But the flip side of these spectacular returns is that investors probably can't expect the remainder of the year to be as good. With this bull market nearly five years old–most bulls don't make it much past three–many market strategists are still predicting solid but unspectacular gains for the year as a whole. Since the market has already handed investors respectable returns, it's hard to imagine it giving that much more in 2007.
To be sure, some market strategists have already begun to raise their targets for the major market indexes. But they've done so only modestly. For example, Citigroup now expects the Dow to end the year at 14,400. That's up slightly from its previous target of 14,000 and gives stock room to climb another 6 percent or so this year.
Whether stocks get there from here will depend on several factors:
Continued growth in corporate profits. Earnings of companies in the S&P 500 grew 8.6 percent in the first quarter, according to a Reuters analysis. While profit growth is expected to slow–analysts project just 5.5 percent growth in the second quarter and 2.5 percent in the third–the bulls do expect a turnaround by the end of the year. In fact, the consensus forecast for fourth-quarter S&P 500 earnings growth is 13.5 percent.
Stable growth in mergers and acquisitions. It's clear that the recent jump in stock prices has been aided by strong growth in M&A activity, which is on a record-setting pace this year. Now, some believe that the private-equity craze could lead to the formation of yet another bubble. But Citigroup's Levkovich notes that most of the deals being made on Wall Street are corporations buying other corporations for long-term strategic purposes–not wealthy investors looking to flip companies for a quick profit.
A stable inflation environment. A big reason the Federal Reserve Board has not begun to lower interest rates–which investors want–is that the Fed remains vigilant about inflation. Despite the slowing economy, "recent statements from Federal Reserve officials continue to paint a relatively hawkish view regarding monetary policy," says Bob Doll, global chief investment officer of equities for BlackRock. "The central bank remains concerned about the tight labor market and about the weak U.S. dollar, both of which are putting upward pressure on inflation."