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Stocks Could End the Year Higher Market Forces May Cause Mid-Year Shift By Ernie Ankrim, Chief Investment Strategist January 25, 2006 By the end of the year I believe the U.S. stock market could be as much as 10% higher than it was at the end of 2005. But the road reaching that point is likely to be filled with valleys as well as hills. Certainly, 2006 started on a good note with the broad equity market gaining 3.4%, as measured by the Russell 3000® Index through Jan. 13. Much of that confidence likely was due to investors looking ahead to the end of the Federal Reserve's interest-rate increases. Investors' confidence was in contrast with the threat of higher rates that hung over the markets for much of the past 18 months. So much so that many analysts feared that the Federal Reserve would continue boosting rates and might force the economy into recession. But, with the Federal Reserve Board widely expected to stop raising rates in the next couple of months, the threat now is being taken off the table. The broad stock market is likely to rise again should the Fed indeed take the step in the next couple of months and stop raising rates. Investors are likely then to become more firmly convinced that recession no longer looms as a threat on the horizon. But, after those gains, as the year unfolds, we could see pressure on consumers resulting in a slowdown in the equity markets. Factors With Impact The pressure on consumers might come from several sources. One might be a reduction in housing demand, along with Federal regulators clamping down on high-risk mortgages. Such a move might reduce the ability of consumers to finance their expenditures by borrowing on home equity. As a result, for the first time in five years I expect we might see no appreciable increase in home equity through 2006, and, should this take place, it could have a dampening effect on consumer consumption. Oil prices also might continue to edge ever higher. Growth in China, which continues to assert a larger influence on marginal global demand, is likely to be a strong driver of higher oil prices. Other commodity prices might continue their upward trends as well. At the same time, I believe that federal deficits and an end to rising short-term interest rates might stop the rising exchange value of the dollar. Although this may not be significant early in 2006, as the year progresses a weaker dollar and sustained demand for commodities might start putting upward pressure on import prices, a trend that could ignite inflationary forces in the domestic economy. Even if the Federal Reserve does not respond by raising rates, nominal rates might increase, driven by inflationary realizations and expectations. The 10-year Treasury Bond, for example, at 4.45% on January 25, might be yielding 5% by the time 2006 is over. Also, should house prices fall, consumers might be less able to borrow money on their homes, particularly should new federal regulations make non-traditional mortgage lending less likely. As a result, stocks might plateau during the second half of 2006. I do not see them falling strongly, however, and many of the gains made during the first part of the year are likely to be retained. But later in the year the forces that caused the market to shift into idle in the first 10 months of 2005 might reassert themselves. These forces also might increase pressure on consumers who might be forced to cut back on their spending as a result. So around the middle of the year I expect we might see earnings comparisons suffering, consumer expectations starting to wane and stock price momentum starting to suffer. Combined, it's possible that they are likely to put a damper on the markets, but are not likely to send stocks tumbling. My Best Estimate
Whatever happens, diversification among asset classes is a prudent investment strategy. Above all, it may be unwise to decrease your exposure to stocks below your target levels based on what occurred last Copyright© Frank Russell Company 2006. All rights reserved. Nothing contained in this material is intended to constitute legal, tax, securities, or investment advice, nor an opinion regarding the appropriateness of any investment, nor a solicitation of any type. The general information contained in this publication should not be acted upon without obtaining specific legal, tax, and investment advice from a licensed professional. Forecasting represents predictions of market prices and/or volume patterns utilizing varying analytical data. It is not representative of a projection of the stock market, or of any specific investment. Russell Investment Group is a registered trade name of Frank Russell Company, a Washington USA corporation, which operates through subsidiaries worldwide. Frank Russell Company is a subsidiary of The Northwestern Mutual Life Insurance Company. Bond investors should carefully consider risks such as interest rate risk, credit risk, securities lending, repurchase and reverse repurchase transaction risk. Greater risk is inherent in portfolios that invest primarily in high yield bonds. They are subject to additional risks, such as limited liquidity and increased volatility. Although stocks have historically outperformed bonds, they also have historically been more volatile. Investors should carefully consider their ability to invest during volatile periods in the market. Growth investments focus on stocks of companies whose earnings/profitability are accelerating in the short term or have grown consistently over the long term. Such investments may provide minimal dividends which could otherwise cushion stock prices in a market decline. Stock value may rise and fall significantly based, in part, on investors' perceptions of the company, rather than on fundamental analysis of the stocks. Investors should carefully consider the additional risks involved in growth investments. Large capitalization (large cap) investments involve stocks of companies generally having a market capitalization between $10 billion and $200 billion. The value of securities will rise and fall in response to the activities of the company that issued them, general market conditions and/or economic conditions. Non-US markets entail different risks than those typically associated with US markets, including currency fluctuations, political and economic instability, accounting changes, and foreign taxation. Securities may be less liquid and more volatile. If applicable, please see a Prospectus for further detail. Small capitalization (small cap) investments involve stocks of companies with smaller levels of market capitalization (generally less than $2 billion) than larger company stocks (large cap). Small cap investments are subject to considerable price fluctuations and are more volatile than large company stocks. Investors should consider the additional risks involved in small cap investments. Value investments focus on stocks of income-producing companies whose price is low relative to one or more valuation factors, such as earnings or book value. Such investments are subject to risks that their intrinsic values may never be realized by the market, or, such stock may turn out not to have been undervalued. Investors should carefully consider the additional risks involved in value investments. Russell 3000® Index: Measures the performance of the 3,000 largest U.S. securities based on total market capitalization. No investment strategy can guarantee a profit or protect against a loss in a declining market. Russell Fund Distributors, Inc., Member NASD. RFD 06-5699. First used: January 2006. |
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