Finaxyz

Stock Market Outlook for 2005

December 13, 2004

Although we don't know where the market will be at the close of 2004 (in three weeks), a lot of the issues for 2005 are quite clear even though the final disposition of those issues is quite murky.

Upside Potential:

Economy continues to improve.
Corporate cost-cutting is showing results.
Corporate profits growing, enabling higher spending.
Restructuring and consolidation is improving the prospects for the remaining companies.
The unemployed are incrementally getting back on their feet.
Despite rising short-term interest rates, there is still plenty of cash available for longer-term investment
Plenty of cash sloshing around to fund new ventures. Venture capital investment is picking up.
Larger companies have the cash to acquire smaller businesses with "hotter" growth prospects.
Population is growing, increasing demand for all manner of goods and services.
Money continues to flow into mutual funds.
Gradual improvement of confidence.

Downside Risks:

Economy growing below its potential, keeping unemployment relatively high.
Still too many businesses chasing too few opportunities (excess capacity).
Potential negative impact of rising short-term interest rates.
Government budget deficits are sucking up cash and putting upwards pressure on interest rates.
Corporate profit growth is relatively anemic.
Businesses still in a cost-cutting mood, holding spending back.
Consumers spending near their limit.
Profitable products and services are incrementally becoming commoditized.
Many stocks appear to be overvalued.
Mutual fund inflows are rather anemic and uneven.
The "falling dollar" has the potential for discouraging inflows to U.S. and encouraging outflows from U.S.
Confidence is still uneven and below potential.

Sure, there are lots of risks, but there is also lots of potential. Ultimately, the net result will be "the sum of all curves" as we add up all the good things that happen and subtract all the bad things.

Unfortunately, there is a lot of negative sentiment out there and 2005 could turn out to simply be a "wait and see" year as we incrementally slog through the issues before us.

There is still a lot of chatter about stocks and the market being overvalued, but there are also people who have different ways of looking at the same data and differing opinions of the outlook for the economy, corporate revenue growth, and corporate earnings over the coming year and beyond. As a general rule, the stock market will tend to look ahead 3, 6, 9, or even 12 months. About all we really know for sure is the economic growth will be uneven, revenue growth will be uneven, and earnings growth will be uneven, but all three will probably be trending up over the full year. Each company will have its own quirky path through this uneven landscape, with some companies stumbling or even failing even as others zoom ahead. We’re bound to continue to have some soft patches in 2005 as different parts of the economy catch up at different speeds and sometimes pause to digest prior rapid growth. While earnings growth is a key factor in determining stock prices, perception of future earnings growth is also a key.

But as important as earnings are, it is ultimately the law of supply and demand that will determine the path of stock prices. Money flows in or out of stock mutual funds will be a key factor in the market trend. Despite the mutual fund scandals, inflows have continued, albeit at a more subdued pace. Mutual fund inflows may pick up more strongly as employment, income, and 401(k) contributions rise. Foreign money flows are a wildcard, but most of the conservative foreign investors have probably stayed away so far anyway, so there is little reason to expect much in the way of foreign outflows from U.S. stocks, despite all the chatter about the dollar and the trade and federal budget deficits.

Some stocks will zoom ahead on anticipation of future recovery and others will lag until investors are convinced that earnings are really sustainable. Some stocks will fall victim to the traditional “buy the rumor, sell the news” maxim and do well in anticipation of earnings improvement and then falter and decline even as strong earnings finally become realized.

Part of the rise or fall of stock prices in any short period is due to the “trading froth” caused by traders and short-term speculators who push the market up further than its core trend or below that trend, but this trading froth will tend to reverse and swing the other way within months, weeks, or sometimes even days.

The single most important thing to remember about the stock market outlook is simply: It's the economy, stupid! Or, more precisely, it's the collective expectations for the economic outlook 6 to 15 months down the road.

The bottom line (assuming the Nasdaq level of 2,128 on Friday, December 11, 2004 is the level at the end of 2004): The major market indices could end 2005 up or down for the year. Nasdaq could end down as much as 30% (to 1,490) or up as much as 60% (to 3,405), depending on the evolution of the economy. The midpoint of that range is 2,450, or a narrow range of 1,800 to 2,800. If you have to press me, my single-point target for Nasdaq is 2,550, a 20% gain.

Hit Counter

Updated: December 13, 2004 12:49:33 AM -0500