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While earnings rise, stocks slumber

Adam Shell USA Today

NEW YORK — Most U.S. companies are raking in big profits this year. Sadly, the same can’t be said for most stock investors.

Despite an improving economy and stronger-than-expected profit growth in the year’s first quarter, the stock market has stalled. Stocks have been trading in a seesaw pattern most of 2004. The result: The market has been trapped in a narrow trading range, unable to add to last year’s 26 percent gain.

The gap between first-quarter profit growth posted by companies in the Standard & Poor’s 500 index and the performance of the stocks themselves is glaring. Profit is up a robust 26.7 percent. Yet the index is up less than 1 percent. “The thing that really bothers me is we have had great-looking earnings, yet stocks are not rallying,” says Price Headley, analyst at BigTrends.com.

The trouble is good economic news has been lost amid headlines about the threat of rising interest rates, Middle East unrest and the spike in inflation.

If the market is to break out, it must overcome a few key obstacles:

• Rising interest rates. Short-term rates set by the Federal Reserve are at 1 percent, a 45-year low. But not for long. Tuesday, the Fed hinted that it was getting closer to raising rates, but it stressed that the increases would be gradual. Rising rates create headwinds for stocks because higher borrowing costs crimp economic growth.

• Decelerating profit growth. Sure, profits jumped sharply in the first quarter, but bears stress that growth is slowing. The estimated 26.7 percent profit growth the first quarter is below the 28.3 percent growth in the fourth quarter of 2003, says Thomson First Call. Analysts expect the pace of growth to slow further.

• Instability in the Middle East. Investors are closely watching Iraq. There is concern that if the situation deteriorates, it will hurt President Bush’s re-election bid. Some investors worry that a Bush loss could jeopardize investor-friendly tax policies.

• Signs of a market top. In the past three months, sharp losses in shares of semiconductors, gold producers and interest-rate sensitive companies like mortgage lenders and home builders have masked deeper problems for the market, says Gary Kaltbaum of Kaltbaum & Associates. “This market can cave very easily,” he says.

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