An Enthusiasm Grounded in Fundamentals

By Terence O'Hara and Brooke A. Masters
Washington Post Staff Writers
Sunday, May 14, 2006

New market high points inevitably are when many would-be investors begin to fret that everyone is getting rich but them, but the time is already past to make big money in the markets.

With the Dow Jones industrials and other major market indexes flirting with historic highs, is this one of those times?

A variety of investment professionals and strategists don't think so. Each expressed the belief that the U.S. equity market's steady, slow climb back from the 2002-03 trough has been driven by bedrock, fundamental strengths in the economy, not speculation. They also say there's very little reason to believe we are at a peak, with a diverse mix of inexorable demographic and economic forces, both here and abroad, pointing to sustainable underlying business performance.

In short, while short-term profits in the stock market are never assured and are dodgy to predict, the long-term chances of building wealth are pretty good, even if you start investing now.

Yet even in the short term, analysts say there are many good reasons to be optimistic about the stock market and the economic cycle in the next year or two.

Among them, stock prices are much lower compared with corporate earnings than they were during both the bubble of the late 1990s and the depths of the stock market slide in 2002.

"The economy is still rising on a reasonable basis. Corporate profits are still rising," said Harvey Hirschhorn, chief portfolio strategist for Bank of America Corp. "I'm upbeat at this time. We think we have lots of risks and uncertainties, but the cycle is favorable to equities investors."

Right now, the firms in the Standard and Poor's 500-stock index are trading at about 16.8 times the previous year's operating earnings per share, compared with 28 times at the index's peak in March 2000 and 20 times at the low point in October 2002, said Sam Stovall, chief investment strategist for Standard and Poor's Corp.

"The market is almost 50 percent less expensive," enthused Jonathan Golub, U.S. equity strategist for J.P. Morgan Chase & Co. "During the late 1990s, profits were healthy and strong, but [stock] price movement far exceeded earnings. Today, it couldn't be more different."

Also, although the Dow is close to its all-time-high close of 11,722.98, set in January 2000, it is not yet close to an all-time record when inflation is factored in. If increases in the consumer price index are included, the Dow would have to reach close to 14,000 to set a true new high, according to William J. Hausman, an economics professor at the College of William and Mary.

Other indexes, such as the S&P 500 and various growth-stock indexes, have risen in recent years but aren't near their all-time highs.

"Value stocks and small-cap stocks have had a great run and have been high relative to large-cap stocks," said Gus Sauter, chief investment officer at the Vanguard Group Inc., a mutual fund company. "Small caps historically trade at a discount to large caps. That discount has been largely wiped out. Large caps haven't had their day in the sun yet, and some people think the time may be now."

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