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Merrill's Doll Sees Stocks 'Muddling Through'

In 2004, Doll accurately predicted that U.S. growth would hit 4% for the first time in five years and that the Fed would double the fed funds rate. But like most analysts, he incorrectly forecast that the 10-year note would climb above 5%.

With so many forces working against the economy in 2005, Doll said corporate profit growth will probably slow to between 5% and 8%, down from the 19% growth seen over the past two years. That, in turn, forms his view about the stock market's potential struggles this year.

In the third year after a bear market has ended, Doll said stocks have historically returned 2.9%. Still, he does expect stocks to outperform both bonds and cash this year and noted that many companies could raise their dividends, buy back stock and increase their merger-and-acquisition activity, given the strength of corporate balance sheets.

Doll also noted that the average stock will probably underperform its index for the first time since 1999, as large-cap and high-quality issues outperform small, low-quality names. It's worth noting that Doll made the same prediction at the start of 2004 and small-cap issues thrived.

As for yawning trade and budget deficits, Doll expects them to improve in 2005 for the first time in 10 years, as the dollar declines and tax receipts go up.

Finally, Doll forecasts that commodity prices will perform well again this year, with oil prices averaging more than $40 a barrel, due to continued geopolitical risks and a lack of spare capacity from the Organization of Petroleum Exporting Countries.

Given all these prognostications, Doll recommends that equity investors seek out high-quality, predictable, dividend-paying stocks this year and suggests an overweight position in international names. He also advocates a position in bonds with shorter durations and said exposure to commodities through hedge funds or private-equity funds is advisable.

Over the next decade, Doll said he expects stocks to grow 8% per year while bonds should gain 5% and cash should return 2%.

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