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Are We In for a Seven-Year Rally?

  • Better mood. A year ago, investors were freaked out about the rising threat of war, orange terror threats, a worsening economy and the stymied hunt for Osama bin Laden. Fear climaxed in the second week of March, just before the start of the war in Iraq, as stock prices fell to their lowest level of the year amid a general revulsion for risk-taking. At present, while combat continues in Iraq and the economy isn't perfect, the country's overall psyche has improved enormously, and we're ready to take risks again.
  • Earnings have improved. Companies ranging from homebuilders to coffee sellers have reported recently that business is much better now than last year. Just last week, teen-oriented retail chains like Hot Topic (HOTT) and Pacific Sunwear (PSUN - Get Report) reported sizable month-over-month increases in comparable-store sales. Surprised investors bid their shares up.
  • CEOs have regained confidence. Professional investors look at least six months into the future when they make stock buy-and-sell decisions. Many skeptical pros are preparing to hear negative guidance on fourth-quarter and 2004 business prospects when companies report third-quarter earnings this month. If chief executives' guidance is rosier than the pros expect, investors will bid prices higher -- possibly explosively. It might well happen. Business confidence surveys published by the Conference Board, Duke University and the Manufacturing Alliance/MAPI all reported in the past two weeks that chief executives feel more positively about economic conditions now than at any time in the past three years.
  • Little competition from bonds. Stocks are always in a battle for investors' affections with risk-free rates of return from U.S. government bonds. When bonds yield 6% or more, they become extremely attractive to professionals. But for the past year-and-a-half, the Federal Reserve has done everything in its power to drive Treasury yields down as low as 3% to 4%, fostering a stronger demand for stocks.
  • Supply of stock lower; amount of capital higher. Bear-market bankruptcies severely cut the number of stocks available in the marketplace, marginally increasing the value of the remaining shares. And mergers continue to diminish the supply of stock available to investors at the same time that few initial public offerings are being made to make more stock available. Meanwhile, the Federal Reserve, the Bush administration and Congress have pumped more dollars into Americans' hands through a variety of means, including tax rebates and an increase in the money supply. Excess capital often finds its way into the stock market, boosting prices.
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