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March 22, 2005 - Dr. Ed Yardeni's Economics Network

March 22, 2005 - Dr. Ed Yardeni's Economics Network

Table A: S&P 500

Table A: S&P 500 Operating Earnings: Bottom-Up vs. Top-Down Forecasts 2005 2006 Date of Latest Change Bottom-Up Analysts' Forecast 74.18 82.06 03/22/05 Top-Down Strategists' Forecasts Oak Associates, ltd.* 75.50 80.00 03/21/05 Alta Vista 72.00 01/05/05 Lehman Brothers 72.00 77.50 02/07/05 ISI 71.75 76.25 02/15/05 McAdams Wright 71.00 03/10/05 Bernstein 70.00 12/16/05 Prudential 70.00 72.00 12/20/04 CIBC World Markets 70.00 75.00 03/09/05 UBS Warburg 69.50 03/12/05 **Average 71.31 76.15 03/22/05 *Earnings are not adjusted for options expensing. Stock options expensing should lower earnings by $1.50 in 2005 and $2.50 in 2006. ** Average excludes Bottom-Up Forecast Source: Oak Associates, ltd, , and Thomson Financial. Table B: S&P 500 Earnings: Yardeni vs. Analysts’ Consensus Forecasts Proforma Operating Earnings Forecast (as of 3/22/05)* Yardeni Analysts' Consensus Level YOY % Level YOY % 2003 55.43 a 18.3 55.43 a 18.3 . 2004 67.18 21.4 67.19 21.2 Q1 15.87 a 26.3 15.87 a 26.3 Q2 16.74 a 24.8 16.74 a 24.8 Q3 16.59 a 15.0 16.59 a 15.0 Q4 17.90 18.4 17.91 18.5 2005 75.50 ** 12.4 74.18 10.4 Q1 17.75 11.8 17.20 8.4 Q2 18.50 10.5 18.28 9.2 Q3 19.25 16.0 18.82 13.4 Q4 20.00 11.7 19.88 11.0 2006 80.00 ** 6.0 82.06 10.6 * Proforma earnings are adjusted for accounting and index composition changes. a = actual ** Earnings are not adjusted for options expensing. Stock options expensing should lower earnings by $1.50 in 2005 and $2.50 in 2006. Source: Oak Associates, ltd. , and Thomson Financial. Page 2 / March 22, 2005 / Investment Strategy Weekly OAK ASSOCIATES, ltd. www.oakassociates.com

Looking Good From Top To Bottom. The bottom line is that S&P 500 forward operating earnings per share is highly correlated with business sales (Figure 8). Business sales is the sum of manufacturers’ shipments, wholesale sales, and retail sales. It is the most comprehensive measure of business revenues. Forward earnings is the timeweighted average of current and next years’ consensus earnings estimates. It is my favorite measure of earnings because I believe it is the one that is “in” the market. At the start of this commentary, I raised my forecast for operating earnings in 2005 and 2006. More relevant for my market forecast, I am also raising my target for forward earnings at the end of this year and next year to $80 per share and $86 per share, respectively (Figure 2). 2 I believe that I am one of the few strategists who focuses on and forecasts forward earnings rather than actual operating earnings when projecting the outlook for the stock market. If the P/E based on forward earnings remains where it is now at 15.7, then my forward earnings forecasts suggest that the S&P 500 will rise to 1256 by the end of 2005 and 1350 by the end of 2006. I am actually expecting that the valuation multiple will rise to 17 later this year and remain there through next year. My S&P 500 targets are 1360 and 1462 for the end of 2005 and 2006, respectively (Table C). I have found that there is a fairly dependable 2-to-1 relationship between the growth rates in forward earnings and business sales. So for example, over the 12-month period through January, sales are up 11.1% and earnings are up 17.9% (Figure 9). The cycles in these two series are nearly identical; their peaks and troughs coincide. What is unusual about the latest cycle is that the growth rate of sales appears to have peaked during May 2004 at 12.4%, but it has remained remarkably steady around 10% through January of this year. It has yet to go into a cyclical decline. If it continues to hang in there around 10%, then even my latest upward revisions to earnings are too conservative. Even assuming a “normal” cyclical decline in revenue growth to 5% by the end of this year would still imply profits could grow 10%. Any way that I slice and dice the numbers suggests that if world trade continues to boost the growth rate in business sales, then we should expect a positive profits surprise, possibly a very significant positive surprise! LargeCaps Win The Derby. In my Topical Study #70 titled “What’s In Style?” and dated February 23, 2005, I explained why I believe that LargeCap stocks will outperform SmallCaps this year. 3 Here is my list of reasons: Over the business cycle, the worst environment for companies is just before and during recessions. At the tail end of economic expansions, the costs of doing business typically rise faster than revenues. Productivity gains are harder to achieve when capacity utilization is high. 2 My previous targets were $77 per share for the end of this year and $82 per share for the end of 2006. 3 See http://www.yardeni.com/pub/t_050223.pdf. Page 3 / March 22, 2005 / Investment Strategy Weekly OAK ASSOCIATES, ltd. www.oakassociates.com

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