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By Richard L. Kesner, President
The CommonWealth Group
February 2007
Strong earnings growth and rising market liquidity drove market performance. The S&P advanced 15.8% for the year and 6.7% in the fourth quarter. Earnings growth for the S&P is expected to top 16% for the last quarter which normally signals a rise in price/earnings ratios. However, we estimate that the P/E for the S&P will finish the year at about 16 times expected earnings; about where it started 2006.
The S&P was not the only market to experience excellent returns. Overall, global equity markets experienced greater liquidity and most had excellent performance in 2006. This liquidity came in many different forms, including merger and acquisition liquidity, rising corporate dividend and stock buy-back programs, and a reduction in the risk premium as global investors become less concerned about the potential for a recession in the U.S. economy.
Most experts were predicting strong performance from large cap growth stocks. However, value investors continued to outperform growth investors and small cap stocks continued their eighth consecutive year of outperfomance relative to large cap stocks. Despite a lot of gloom and doom to start the year, the last four years represents one of the strongest bull markets on record. The S&P set a 6-year high and achieved its fourth straight year of gains. All ten economic sectors within the index rose in 2006 and 80% of the sectors had double digit gains.
2007 Outlook
Going into 2007, the fundamental outlook for the markets is favorable. Economic growth is moderating but appears sustainable, earnings growth has remained positive, and equity valuations are reasonable. We are concerned, however, that market sentiment may be reaching overly bullish levels. Therefore, we will be somewhat cautious going into the year. Finally, if the economy heats up, the Fed may again feel the need to curb inflation by raising interest rates. Such a move may have an adverse effect on the markets.
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