Equity Strategists: Garzarelli Predicts 25% Gain in S&P 500

June 20 (Bloomberg) -- The Standard & Poor's 500 Index may surge 25 percent in the next 12 months, bringing the benchmark near the record high it touched in 2000, according to Elaine Garzarelli, president of Garzarelli Research Inc.

Producers of raw materials, along with industrial and financial shares including 3M Co. and Citigroup Inc., will lead the market higher, she said. An end to the Federal Reserve's series of interest-rate increases later this year will provide the catalyst, spurring economic growth and investor optimism.

"The S&P 500 is overweighted with financials and other industries that will move quite nicely once the Fed stops tightening," said Garzarelli, a more than 20-year veteran in finance and economics.

Garzarelli, who correctly predicted the 1987 market crash, provides research to 111 institutional clients that each manage more than $100 million. She uses a 14-indicator model to predict overall moves in the stock market and industry groups that will outperform. A reading of 65 percent or higher on a scale of zero to 100 percent is a buy signal for the S&P 500; below 30 percent is a sell signal.

In February, a level of 43 percent suggested the benchmark would fall 10 to 15 percent, the New York-based Garzarelli said. The S&P 500 climbed to a 2005 high of 1225.31 on March 7, before then dropping 7.2 percent to a low of 1137.50 on April 20.

Second-Most Bullish

Garzarelli's S&P 500 forecast is about 14 percent higher than the next-most optimistic prediction among six Wall Street strategists surveyed by Bloomberg News who give 12-month estimates. Goldman Sachs Group Inc.'s Abby Joseph Cohen is the second-most bullish, expecting the S&P 500 to reach 1325 within 12 months. The average forecast is 1276.

Garzarelli worked at Lehman Brothers Inc., among other Wall Street firms, before starting her own company in 1995. It was as a strategist at Lehman that she won attention for forecasting the 1987 market crash.

In 2000, Garzarelli told Bloomberg News that stocks were overvalued and would fall no more than 20 percent. She expected the market to trade within a fairly narrow range through the end of the year. The S&P 500 dropped 9.6 percent by that December and later rounded off a 33 percent retreat over the next two years.

While at New York University, where one of her roommates dated Federal Reserve Chairman Alan Greenspan, Garzarelli worked at Drexel Burnham Lambert developing an econometric model to explain moves in the stock market. She continues to use a modified version of what she came up with that summer, using monetary, economic, valuation and sentiment indicators.

Market Leaders

The S&P 500 has rebounded 6.7 percent since April 20. Garzarelli expects cyclical shares -- producers of chemicals, paper and aluminum, as well as industrial and financial companies -- to lead the index from here as their earnings grow with the expanding economy. She says profit growth among S&P 500 companies will average about 12.3 percent in 2005.

An S&P 500 measure of industrial shares may have an earnings increase of 14 percent in the second quarter and 18 percent in the third quarter, according to a Bloomberg analysis of Thomson Financial data. Materials stocks may post growth of 7.1 percent and 14.6 percent, and financials of 1.7 percent and 26 percent.

Shares of companies such as Bowater Inc., the biggest U.S. newsprint maker, have fallen to inexpensive levels, according to Garzarelli. Bowater, which is down 21 percent this year, is expected to report a loss of 1 cent this quarter and a profit of 23 cents in the third quarter, based on the average analyst estimate compiled by Thomson.

Interest Rates

Interest rates are key to the current rally, according to Garzarelli.

"When the Fed tightens, usually the long rate goes up with the short rates," she said in an interview on June 16 from her office in New York. "This time it didn't. That's unusual, and what that did was turn around and stimulate the economy again."

The yield on the benchmark 10-year Treasury note was 4.07 percent on June 17, a little more than 1 percentage point above the Fed's target rate. The last time the difference was this narrow was 2001, when the central bank was cutting rates. Today, the yield rose 4 basis points to 4.10 percent. The Fed has lifted its target rate eight times since last June.

Garzarelli expects the Fed to continue boosting its target rate to 3.75 percent and stop after its Sept. 20 meeting. A sharp rise from here in long-term interest rates or oil prices pose the biggest threat to the potential stock rally, she said.

Oil prices in New York surged above $59 a barrel today to $59.23, the highest since crude futures debuted on the New York Mercantile Exchange in 1983.

"If the long rates go much higher or oil goes much higher, then things will slow again," she said. "But right now, things look pretty good."

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