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Merrill's Callies Says Bottom Builds, but Lowers Year-End S&P Target

Spurred by the current market falloff, strategists have been rejiggering their year-end outlooks -- and trying to remain optimistic. Yesterday it was uber-bull

Abby Joseph Cohen of

Goldman Sachs

. Today, it's

Merrill Lynch's

Christine Callies, who lowered her year-end target for the

S&P 500.

But Callies also said she thinks the prerequisites for a market "trough" -- or interim bottom -- are building.

Callies blamed the broad-based S&P 500's inability to meet Merrill's original year-end target on the elections quagmire. She lowered Merrill's year-end target to a range of 1450 to 1460 from the earlier projection of 1575. Still, Merrill maintained a medium-term target of the low 1700s. Callies expects selected defensive stocks to be the best performers until the election is decided, when stronger performance could then be expected to extend into other sectors.

"Once the uncertainty has been resolved, however, we expect leadership to broaden to include a broad array of growth cyclicals, including technology, high-quality consumer cyclicals, medical technology, technology hybrids in capital goods, and utilities. Financials would continue to prosper if rates are cut," the report said.

While the deceleration in corporate profits and capital spending remain a problem, Callies said the case for a market trough could be found in the accumulation of cash on the sidelines, a fundamentally strong backdrop for earnings and the likelihood of an easing in interest rates by the

Federal Reserve.

According to Callies report, cash levels have risen on slight declines in long-term interest rates, widely-distributed moderate profit growth and rising pessimism among traders in index options. Economic fundamentals remain strong as "analyst earnings revision activity coming out of confession season has not been substantially worse than in past years, according to IBES." IBES is a firm that tracks corporate earnings warnings and earnings reports.

And as data showing a slowing economy have accumulated, expectations have grown that a Fed interest rate cut is not far off.

Fed funds futures contracts are now discounting more than 100% odds that the

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fed funds rate will be 6.25% by April, down from the current 6.5%.

Callies was not alone today in her upbeat take on the market. This morning,

J.P. Morgan

strategist Doug Cliggot raised his equities allocation to 60% from 50% and dropped his bond and cash allocations to 20% each from 25%.

And yesterday, Cohen, Goldman's chief equity strategist, reiterated her 12-month target for the S&P 500 of 1650, which would be a 25% gain in the next year. Cohen did not mention her earlier year-end target for the S&P of 1575.

Market strategists said basically the same thing two weeks ago. Joe Battipaglia at


, Thomas Galvin at

Credit Suisse First Boston

, Jeffrey Applegate at

Lehman Brothers

, Robert Robbins at


and Callies of Merrill each said that while the election uncertainty might delay the expected post-election, year-end rally, the backdrop for stocks remains favorable.

At that time, Callies upped her recommended allocation of equities by 5% -- well-timed since Merrill's proprietary 16-year-old "Sell Side Indicator" (which is a poll of top strategists' allocation to equities) had just hit an all-time high.