Optimism for corporate earnings is beginning to take hold on Wall Street as fourth quarter earnings are coming in better than expected. This could be the spark that ignites the big rally that I have been telling you to expect. The anticipated rally could propel the market averages to new highs sometime during the 2nd quarter which ends in May. I am anticipating that interest rates will be a major focus in the 3rd quarter, as the market begins to focus on inflation, and the effects higher interest rates will have on corporate profits.
At the start of the 4th quarter, analysts estimated that earnings for the S&P 500 would grow by 15.5%. As it turns out, these estimates were much lower than the actual results. As of last week, Q4 2004 earnings for the S&P 500 were coming in at 19.8% compared to the 28.3% growth rate posted in the fourth quarter of 2003.
Even though earnings growth for Q4 2003 was the highest growth rate registered by the S&P in ten years, we need to be ALERT for an evolving trend. The trend is telling us that earnings comparisons looking forward are going to be more challenging, and higher interest rates will eventually take their toll on consumer spending.
MARKET CYCLES EVOLVING We are beginning to see changes in the stock market cycle as big market players are beginning to bid up the prices of defensive stocks. As we approach a peak in the business and stock market cycle, we are seeing Consumer Non-Cyclical stocks such as food, beverages, tobacco, and cosmetics begin to climb higher. Also, the Healthcare Sector has begun its move upwards as HMO痴, medical equipment, and pharmaceuticals have attracted buying interest.
On the flipside, Consumer Cyclicals, Financials, Industrials, and Precious Metals are beginning to give way to profit taking. Energy prices will stall in the near future as will demand for Basic Materials such as metals, chemicals and paper. I like the Energy and Basic Materials sectors long term, but both are due for a period of weakness over the next 12-18 months.
WHAT TO DO NOW
I would focus on buying defensive stocks and selling cyclical stocks. Specifically, I like Coca-Cola (KO) at current levels. Coke is in the beginning stages of a major turnaround, and is replacing its artificial sweetener (aspartame) in Diet Coke with the natural sweetener Splenda. This is a major move for Coke, and many critics fear that Coke will ruin the branding of their biggest seller by changing the sweetener. Everyone still remembers what happened when the company replaced Coke with New Coke.
The health hazards of aspartame have been well documented. By adding Splenda to their products, Coke will attract new customers in the US as well as abroad where Coke痴 products have been viewed as a potential health hazard.
