The S&P 500 index has been moving up — in fits and starts — for the past few weeks, as investors struggle with several factors that have been constraining upside potential. S&P believes the two primary culprits have been uncertainty about when the Federal Reserve will end its monetary tightening policy and concern over the pace of future earnings growth.
The Investment Policy Committee's favorable 2006 equity market outlook is based in part on our belief that the Fed will discontinue its tightening policy after its May meeting. The benign core consumer price index (CPI) report on February 22 supported this view. On the earnings front, S&P equity analysts expect that earnings, while decelerating somewhat from 2005's pace of 13% growth, will rise 11% in 2006. As a result, the Standard & Poor's Investment Policy Committee continues to have a positive outlook on U.S. equities and forecasts a 9% return, before dividends, for the "500" in 2006.
Our overweight recommendation on financials is based largely on our belief that the sector will benefit from an end to Fed tightening. Our positive fundamental outlook on the sector is based on what we see as modest valuations, attractive dividends, and high S&P Quality Rankings.
Our overweight recommendation on energy reflects the likelihood of elevated energy prices throughout 2006. S&P forecasts an average crude oil price of $61.50 in 2006 vs. the $56.49 average in 2005. In addition, the sector appears attractively valued.
S&P recommends overweighting health care, which trades at 18 times estimated 2006 earnings. Our equity analysts are predicting strong revenue and earnings growth for this sector.