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|  | SEPTEMBER 29, 2004
 SAM STOVALL'S SECTOR WATCH By Sam Stovall Third-Quarter Winners and Losers Warnings have been plentiful, though the S&P 500's average earnings gain was respectable. Here's how various sectors fared Investors have had something to cheer about over the past year or so: During each of the past four quarters, the S&P 500 posted year-over-year operating earnings increases in excess of 20%. In addition, these quarterly results were -- much to investors' surprise and delight -- not preceded by a spate of earnings warnings. This quarter, however, things seem to have changed. Warnings have become more frequent, particularly in the consumer-staples sector where the likes of Coca-Cola (KO ), Dean Foods (DF ), General Mills (GIS ), and Colgate-Palmolive (CL ) have sent investors scurrying from this otherwise secure nest of what we regard as high-quality issues in search of other safe havens. TOUGHER COMPARISONS. In response, on Sept. 22, S&P downgraded its investment outlook on the group to "underweight" from "marketweight," citing high energy and input costs, increased competitive activity, and a weak retail environment. What does the bigger picture look like? Check out the table below:
The third-quarter slump has several reasons: tougher comparisons (it's difficult to grow earnings at more than 20% for an extended period), plus softening consumer spending, exacerbated by higher energy prices and challenging East Coast weather. A further factor is the firming U.S. dollar in response to the start of the Fed's rate-tightening program, which may lessen the benefit of currency translations. Still, a 14% rise in earnings allows an otherwise flat stock market to play valuation catch-up, which may eventually be highlighted as a reason to become more optimistic toward equities. As can be seen in the bar chart below, the S&P 500 trades anywhere from a 33% to 60% discount to its prior bubble peak using either operating or GAAP (as reported) earnings. In fact, the 500's trailing 12-month p-e on GAAP earnings of 20.3 is below the average p-e since March, 1982. (The average p-e declines to 15.5 when extended back to 1935.) 
As with any reporting period, some winners and losers are expected. The table below shows the subindustries in the S&P Composite 1500 projected to show the best and worst third-quarter year-over-year earnings performances on a bottom-up, market-weighted basis. Included are companies with either favorable or unfavorable investment outlooks by S&P analysts (note: no steel stocks were ranked higher than three STARS).
Industry Momentum List Update For regular readers of the Sector Watch column, here is this week's list of the industries in the S&P 1500 with Relative Strength Rankings of "5" (price performances in the past 12 months that were among the top 10% of the industries in the S&P 1500) and their proxies (the highest STARS-ranked companies in the subindustry index; tie goes to the largest market value) as of September 24, 2004:
Required Disclosures As of June 30, 2004, SPIAS U.S. research analysts have recommended 35.9% of issuers with buy ratings, 52.7% with hold ratings and 11.4% with sell ratings. 5-STARS (Buy): Total return is expected to outperform the total return of the S&P 500 Index by a wide margin, with shares rising in price on an absolute basis. 4-STARS (Accumulate): Total return is expected to outperform the total return of the S&P 500 Index, with shares rising in price on an absolute basis. 3-STARS (Hold): Total return is expected to closely approximate the total return of the S&P 500 Index, with shares generally rising in price on an absolute basis. 2-STARS (Avoid): Total return is expected to underperform the total return of the S&P 500 Index and share price is not anticipated to show a gain. 1-STARS (Sell): Total return is expected to underperform the total return of the S&P 500 Index by a wide margin, with shares falling in price on an absolute basis. All of the views expressed in this research report accurately reflect the research analyst's personal views regarding any and all of the subject securities or issuers. No part of analyst compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed in this research report. Other Disclosures This research report was prepared by Standard & Poor's Investment Advisory Services LLC ("SPIAS"). The research and analytical services performed by SPIAS are conducted separately from any other analytical activity of Standard & Poor's. No research analyst that prepares a research report on a subject company has a financial interest in or is associated with that subject company. SPIAS is affiliated with other entities, which may receive compensation for performing services for companies covered by Standard & Poor's Equity Research Services. Disclaimers This material is based upon information that we consider to be reliable, but neither SPIAS nor its affiliates warrant its completeness or accuracy, and it should not be relied upon as such. Assumptions, opinions and estimates constitute our judgment as of the date of this material and are subject to change without notice. Past performance is not indicative of future results. This material is not intended as an offer or solicitation for the purchase or sale so any security or other financial instrument. Securities, financial instruments or strategies mentioned herein may not be suitable for all investors. This material does not take into account your particular investment objectives, financial situations or needs and is not intended as a recommendation of particular securities, financial instruments or strategies to you. Before acting on any recommendation in this material, you should consider whether it is suitable for your particular circumstances and, if necessary, seek professional advice.  Stovall is chief investment strategist for Standard & Poor's All of the views expressed in this research report accurately reflect the research analyst's personal views regarding any and all of the subject securities or issuers. No part of analyst compensation was, is or will be, directly or indirectly related to the specific recommendations or views expressed in this research report. Standard & Poor's Regulatory Disclosure Any advice, analysis, or recommendations contained in articles labeled "Insight from Standard & Poor's" reflect the views of Standard & Poor's, which operates separately from and independently of BusinessWeek Online. It is possible that BWOL may from time to time publish information that is not consistent with advice, analysis, or recommendations that are published by Standard & Poor's. Standard & Poor's and BusinessWeek Online are each units of The McGraw-Hill Companies, Inc.
BW MALL
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