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Will the markets' frenzied rally continue? Some observers are betting yes. "This is a great time to be an investor,” said analyst Michael Farr.
By John W. Schoen Senior Producer
updated 10/19/2006 7:30:22 PM ET 2006-10-19T23:30:22

After seven long years, much of it spent wandering in the investment wilderness, the 30 major stocks that make up the Dow Jones industrial average notched another millennial milestone Thursday.And though it took the market several tries to cross the 12,000 line, some investment analysts say the current rally still has legs on it.

After taking less than six weeks to rocket from 10,000 to 11,000 in the spring of 1999, the widely watched stock market index began the new century in a long, slow slide — thanks to a steep slump in corporate profits. By September 2002, the Dow had fallen below 7,300.

Now with corporate profits rising, energy prices falling and the Dow setting new highs, “this is a great time to be an investor,” according to Michael Farr, an investment manager based in Washington, D.C.

“We've got a stable energy environment, prices and costs falling,” he told CNBC recently. “We have a stable interest rate environment, and a stable interest rate expectation for the markets, and we've got companies continuing to earn.”

That growth in corporate earnings has been the foundation on which the current market rally has been built. After peaking in 2000, corporate operating profits for the 500 companies tracked by Standard and Poor’s hit a low of just over $9 a share in the second quarter of 2001. Since then, profits have more than doubled — to nearly $22 a share for the second quarter of this year. But so far the Dow has gained just 50 percent from its low in 2002.

“The market has not caught up to the earnings that have been produced over the last couple of years," Strategas Research Partners Chief Investment Strategist Jason Trennert told CNBC. “You're going on four years of double-digit earnings gains quarter after quarter. And the market obviously is doing okay, but it hasn't caught up to the level of earnings. I think that's going to happen, especially when you start to think the Fed is going to get out of the way.”

After pushing short-term rates as low as 1 percent in 2003, the Federal Reserve set a course of relentless rate hikes that lasted until this summer, when the central bank held rates steady at 5.25 percent. Now, with inflation still relatively tame and oil prices well off their highs, many analysts see a bright outlook for continued gains in corporate earnings. The consensus forecast of Wall Street analysts sees total S&P 500 profits rising to more than $25 a share by the fourth quarter of next year, according to S&P.

That has some investment managers looking for the S&P 500 to break through its all-time high of 1520, reached in September 2000. That index, a wider — and some say more reliable — barometer than the 30 stocks that make up the Dow, closed Thursday at 1367, or about 10 percent off its peak.

The Nasdaq Composite index — which hit its peak in March 2000 at the height of Internet mania — closed Thursday at 2341, less than half its all-time high of 5049.

So where do stocks go from here? A lot depends, of course, on whether energy prices remain tame and how well the economy holds up in the face of a rapidly slowing housing market. Some economists caution that a prolonged slide in housing prices could put a big crimp in consumer spending, which makes up roughly 70 percent of U.S. economic activity. So far, the bulls on Wall Street seem to be convinced that the odds favor a hoped-for “soft landing” next year that would allow the U.S. economy to dodge a recession.

“The economy has been slowing for a while, but we don't expect the kind of slowdown that a lot of people have been talking about,” David Goerz, chief investment officer at Highmark Capital told CNBC.

Some industries are expected to fare better than others. Analysts see the biggest profit gains from from companies that sell consumer products, information technology and telecom equipment and services. Healthcare companies are also expected to do well.

“We think going forward a bigger percent of (gross domestic product) is being spent on health care, and we're going to see (spending) growth even if the economy slows down,” said Sarat Sethi, a portfolio manager at Douglas C. Lane & Associates.

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