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Don't count out the bull

Despite the signs of a slowing economy, the case for stocks remains strong.

By Stephen Gandel, Money Magazine senior writer

NEW YORK (Money Magazine) -- Are you scared yet? After enjoying records for the Dow and the S&P throughout the spring, investors have faced some rough selloffs in June.

Now you may be worrying about the falling dollar, the collapsing housing market and the slowing economy - and what that will do to your retirement accounts.

No one ever knows stocks' short-term path, of course, but nothing about this market, even at today's levels, should throw off your long-term plan. In fact, the outlook for stocks is surprisingly solid.


The economy is doing well (except for housing and autos)

Real estate's woes haven't been spreading Bears are focused on big-picture data that show the pace of economic growth slowing. But excluding homes and autos, the economy looks pretty good, says James Paulsen, chief investment strategist of Wells Capital Management.

While problems in the housing sector could still spread to the rest of the economy, it's been almost a year since the real estate bubble began to burst. Federal Reserve chairman Ben Bernanke recently said he didn't think housing posed a danger.

Profits exceed expectations Corporate profits, which climbed swiftly for the past three years, are not rising as fast as in 2007.

Still, earnings have far exceeded expectations this year, and profit growth is expected to rebound into the double digits in 2008.

That's good news for stock prices, which usually follow the bottom line.

Deals, deals and more deals Acquisitions typically buoy the market because they drive up stock prices. And 2007 looks to be the year of the buyout, with a half-dozen $20 billion-plus deals announced, such as college lender Sallie Mae and utility TXU.

And there is no sign of an end to the trend. Leveraged buyout funds have raised more than $300 billion to do deals.

Stocks still looks under-valued

Everyone's a winner (well, nearly everyone) When a bull market consists of relatively few stocks rising rapidly - think Internet companies in the late 1990s - that's usually a bad sign.

Happily, the recent run of good luck on Wall Street has been spread around the entire market. The shares of more than three-quarters of the companies in Standard & Poor's 500 are up in 2007.

"People are interested in stocks again," says David Poiesz, who manages the Oppenheimer Growth Fund.

Stocks are still cheap Five years into the bull market, the price-to-earnings multiple of the S&P 500 stands at 17, below its 25-year average of 20.

For it to return to just average, stocks would have to rise another 18 percent. Some strategists, like Tobias Levkovich at Citigroup Wealth Management, believe that the market remains as much as 20 percent undervalued today.

The outlook is strongest for large-cap growth stocks

Defensive stocks are on the rise One worrisome sign: Defensive stocks like health care and consumer staples, which generally hold up well when the economy dips, have been strong lately.

For example, pharmaceutical stocks Schering-Plough and Merck are up 31 percent and 14 percent, respectively, this year. That's a sign investors don't believe the bull market will continue.

On the other hand, commodities and economically sensitive stocks like Alcoa and tractor maker Deere, which soared during the booming economy of the past few years, have continued to do well so far in 2007.

Time for growth to take a turn The performance of mutual funds that invest in value stocks - that is, those trading at a low price compared with their earnings - has vastly trumped the performance of growth funds for five of the past seven years.

It's one of the longest stretches of outperformance for the value group, which suggests that growth investors' turn may be coming soon.

Large looks inexpensive Smaller companies tend to trade at higher price-to-earnings multiples than larger companies. But the difference in the P/Es between smaller companies and larger ones is unusually wide, which could mean large-cap stocks are underpriced, says Ed Clissold of market watchers Ned Davis Research.

And larger companies may benefit from the falling dollar because they sell more overseas.

So will the Dow break more records this year? No one really knows. Besides, market timing is a sucker's game. As long as you have a well-diversified portfolio, there's no reason to run from this bull. Top of page