The market
Stocks will post higher gains in 2005, despite slowing economic and profit growth.
There’s pent-up demand for equities as investor worries about fast oil price hikes, terrorism, and the election begin to ease.
Plus the bigger GOP edge in Congress improves odds that tax cuts on earned income, dividends, and capital gains will be lasting.

Stocks will return from 12% to 15% ... at least a 10% jump in the S&P 500 plus an average dividend yield of 2% or so.
That’ll outstrip profit growth of 10% on average for S&P 500 companies. In part, that’s because the market will be playing catch-up after an average return of 7%-8% this year ... less than half expected 2004 average profit growth of 18% for S&P firms.
Also feeding the robust growth: Less-alluring alternatives. Ongoing increases in interest rates will dampen the value of bonds, while one-year CDs will still yield only 2.5%. Home price appreciation should slow and even reverse in some areas, curbing investment interest.

Overall, equities are fairly valued. Near 17, the average ratio of prices to anticipated earnings is close to the 25-year average of 15.
That argues for selectivity, picking the stars out of the field.
And a focus on well-regarded blue chips with handsome dividends. They tend to shine over small caps at this stage of the economic cycle.

Among the most promising sectors: Defense. Global uncertainties and Iraq spell continued strong government spending. Look for Raytheon, Lockheed Martin, and L-3 Communications to reap considerable benefits.
Energy, feeding off rising long-term demand for fuel as China, India, and others prosper. ExxonMobil, ChevronTexaco, ConocoPhillips, and specialized exploration firms, such as Anadarko, warrant a look.

Retail stocks are a mixed bag. With online purchases soaring, eBay is attractive. Wal-Mart, Lowe’s, and CVS are also worth a gander. But many retailers will see sales growth decline in the coming year.
The same goes for health care. Merck’s woes and a political push for cheaper drug imports aren’t good news for pharmaceutical companies. But managed care firms ... Humana, PacifiCare ... are poised for a nice lift as more employers steer workers toward using Health Savings Accounts.
Airlines, automakers, and auto parts firms are risky propositions, rocked as they are by stiff competition and high energy prices.
Due for a pause: Utilities, after a hefty, dividend-led rally.
Good tech bets are in software and services, notably Microsoft. Signs of slowing in business investment may hurt equipment vendors.

Business costs
The biggest postal rate hikes in decades loom ... just a year away.
First-class stamps: To 41¢ from 37¢ now. Depending on mail volume and how much presorting is done, other mailings will be hit even harder:
18%-22% more for magazines, catalogs, overnight mail, and so on.
For mass mailers, that will come on top of paper price increases that are already biting and threaten to cut even more deeply next year.
Coated paper ... up an additional 7%-8% by April, possibly more if Canadian paper-mill workers follow through on strike warnings.
And a similar increase for photocopier and printer paper supplies is likely over the same span ... about 4% by year end, another 4% by April.

The economy
Chances of another interest rate hike this year: About 60-40. Strong job growth in November ... 175,000 or better ... would seal it. If so, figure that prime lending rates will hit 5.25% by year end.

It certainly won’t dent the construction industry very much. While housing starts should dip a bit next year, nonresidential building will pick up, growing about 9% in 2005 compared with a 5% jump in 2004. Job growth will spur building of more hotels, factories, and offices. But retail consolidation will crimp gains in store and mall construction. Highway and bridge projects are mostly on hold, pending a thumbs-up from Congress on more highway spending. Funds will start to flow in 2006.

United, US Airways, and Delta aren’t the only airlines in trouble. Low-cost carriers also teetering on the edge: Independence Air, Midwest Express, and ATA. Bad planning and high fuel prices are to blame. Some upstarts tried to grow too big too fast, borrowing heavily and underestimating rivals. Half-empty planes hurt Midwest and Independence. ATA filled seats but got caught in a price war.

The stronger carriers will pick up the pieces: Southwest, JetBlue, and AirTran are eager to snatch ATA’s slots at Chicago’s Midway and Independence’s gates at Washington’s Dulles.

© 2004 The Kiplinger Washington Editors, Inc.