by Archie M. Richards, Jr., CFP^®
January 2, 2005

In January 2004, I predicted that 2004 would be an especially good year for stocks. It wasn't; prices went up only modestly.

In January 2005, I said that the good market that didn't happen in 2004 would arrive in 2005. Nope, prices rose a tiny amount. (Foreign stocks rose smartly, however, causing the portfolio recommended in this column to perform well.)

For successful investing, diversification is essential. Predicting the stock market is not.

Even when a market prediction proves to be right, take the guru who makes it with a grain of salt. Let's say I predict that 2006 and 2007 will be terrific years (which I'm about to do). If I turn out to be right, I might then boast about what a keen fellow I am.

You should respond, "Listen buster: Your other two predictions were wrong. You were right on only one-out-of-three. Pipe down!"

Okay, here we go: 2006 and 2007 are going to be excellent years for stocks. What happens in early-2006 I don't know. But beginning in the latter half of the year, the market will rise big time.

Why the latter half?

As you know, 2006 is the 2nd year of Mr. Bush's four-year Presidential term. Presidents prefer to get bad news out of the way early in their terms. Time and time again, stock prices bottom during the last half of the 2nd year, followed by a substantial rise.

I checked this out. Since 1894, there have been 28 second-years-of-presidential-terms. In two of them (1954 and 1958), the Dow went up without a break all year. Those I don't count.

In the other 26 years, the Dow fell during a portion of the year by an average of 18 percent. In all but three of those years, the low point occurred during the year's latter half.

The market then rose for an average duration of 8 months. Here's how much:

• During the 5 second-years from 1894 to 1910, the returns from the bottom of the market until the next obvious peak averaged 21 percent.

• In the 21 second-years since 1910, the gains from the low point averaged a whopping 47 percent! In some cases, the advance continued for over a year without a break. Even during the Great Depression, the Dow rose by 20 percent from December 1930 to February 1931, before the market resumed its downtrend.

More than a century of such consistency is too solid a record to ignore. I predict that stock prices will rise substantially in the next two years, probably beginning in the latter half of 2006.

Comparing stocks with bonds gives another indication of where the market's headed. Here's an explanation:

To find a company's dividend yield, you divide the annual dividend by the price. On the S&P 500, the dividend yield is now 1.8 percent.

You find the earnings yield similarly: Divide the annual earnings by the price. Currently, the earnings yield on the S&P 500, based on estimated earnings for the next 12 months, is approximately 6.2 percent.

Compare this with the interest yield on 10-year U.S. Treasurys. This is only 4.4 percent.

Normally, the Treasury interest yield is higher than the S&P 500 earnings yield by about 1.75 points. Whenever the reverse is true, the stock market rises substantially.

The Treasury interest yield, at 4.4 percent, is now considerably lower than the S&P 500 earnings yield, at 6.2 percent. This signals that stock prices are headed up over the next two years, big time.

There's plenty of other good news: The democratization of Iraq progresses gloriously. Despite severe hurricanes and high energy prices, the economy spurts ahead by 4 percent a year. Mergers, acquisitions, and stock buy-backs - always harbingers of rising stock prices - are now common. At all levels, U.S. households are getting wealthier, and the ratio of household debts to assets is only 18.3 percent, showing excellent financial health.

The media is way too pessimistic. Overall, the prospects for U.S. stocks over the next two years are excellent.