By Lynn Thomasson – Jun 1, 2010
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Pimco CEO Mohamed El-Erian speaks during a conference. Photographer: Joshua Roberts/Bloomberg

The biggest monthly drop in the Standard & Poor’s 500 Index since February 2009 is ratifying Mohamed El-Erian’s prediction for a new normal of below-average returns. Analysts say not so fast.

Combined price estimates from more than 2,000 forecasters tracked by Bloomberg show the S&P 500 will rise 27 percent in the next year, the fastest projected rate since February 2009, data compiled by Bloomberg show. The rally above 1,350 will be led by industries most tied to the economy, according to analysts who boosted individual share projections by an average of 0.9 percent in May, the 14th straight monthly increase.

The estimates show Wall Street firms are discounting El- Erian’s assertions as well as Europe’s credit crisis and instead focusing on economists’ growth projections, which call for U.S. gross domestic product to expand 3.2 percent this year and 3.1 percent in 2011. Analysts are telling investors to buy landlord AvalonBay Communities Inc. and tractor maker Deere & Co. to benefit from the fastest expansion in six years.

“There’s a lot of potential demand embedded in analysts’ expectations that I think will be very real,” said David Goerz, who oversees $17 billion at Highmark Capital Management Inc. in San Francisco. “Traders are trying to layer on a debt crisis similar to what they saw in 2008 and drawing the same conclusions, even though it couldn’t be more different.”

Estimates for companies in the S&P 500 show profits may jump 19 percent in 2010, the most since 1995, and 18 percent in 2011, according to data compiled by Bloomberg. The index trades for 13.2 times 2010 per-share earnings forecasts, compared with an average multiple of 16.4 times reported income since 1954.

Highest Since 2008

Should analysts’ forecasts for a 27 percent gain in the S&P 500 come true, the gauge would climb to 1,360 by next May, the highest level since June 2008. The projected advance reflects individual share-price estimates for all the companies in the index, adjusted according to their weighting. The S&P 500 fell 1.7 percent to 1,070.71 today.

More than 77 percent of S&P 500 companies beat first- quarter profit estimates, data compiled by Bloomberg show. The surprises failed to keep the S&P 500 from tumbling 8.2 percent in May as Spain lost its AAA credit grade and bank funding costs increased to the highest levels since July.

The retreat cut the rally that began almost 15 months ago to 58 percent from as much as 80 percent at its peak on April 23. The plunge came as the London interbank offered rate for three-month dollar loans rose for 13 consecutive days through May 27 to 0.538 percent in a sign banks are becoming more reluctant to lend, the British Bankers’ Association reported.

Odds of Default

Credit default swaps on Greece signal a 45 percent chance the country will fail to repay its debt within five years even after the European Union pledged almost $1 trillion to ease the region’s budget crisis. The Athens Stock Exchange Composite Index has dropped 30 percent this year, the Euro Stoxx 50 Index has lost 12 percent and the S&P 500 has fallen 4 percent.

“Structural changes are often omitted from analysts’ assessments until the evidence is truly overwhelming and the implications have already imposed themselves,” El-Erian, who oversees $1.1 trillion as chief executive officer and co-chief investment officer at Newport Beach, California-based Pacific Investment Management Co., wrote in an e-mail to Bloomberg. “Structural changes are among the hardest things for analysts to identify and to price.”

‘Groundless’ Reports

The S&P 500 climbed 0.2 percent to 1,089.41 last week. Since falling as low as 1,040.78 on May 25, the benchmark index for American shares rallied 2.9 percent after China’s State Administration of Foreign Exchange said a report that it may reduce holdings of euro assets was “groundless.” The agency has $2.4 trillion of foreign-exchange reserves, the world’s largest.

None of the 13 U.S. equity strategists tracked by Bloomberg News has reduced his prediction for the S&P 500’s level at the end the year. The average outlook is for the measure to close at 1,268 on Dec. 31, an 18 percent gain.

“Growth is coming through pretty well and there’s obviously some spillover from what’s going on abroad, but it’s probably not enough to move the needle,” said Myles Zyblock, the chief institutional strategist at Royal Bank of Canada in Toronto. “We went from no worries at all to very pervasive worries about everything, so that might be a good time to scale back in a little bit.”

‘Best in Class’

AvalonBay shares may rise 12 percent to $108 in the next year, according to Paula Poskon, who covers developers for Robert W. Baird & Co. in McLean, Virginia. Poskon told investors to buy the Arlington, Virginia-based company on May 25. Her stock-price forecast is the most bullish among 14 analysts tracked by Bloomberg.

“As the global chaos brought a broad selloff to the market, it felt like it put best-in-class, high-growth stocks on sale,” said Poskon, whose picks have earned investors 38 percent over the past year. “I’m a believer in the growth story in the second half of 2011, 2012 time frame.”

Credit Suisse Group AG, based in Zurich, and Jefferies Group Inc. of New York are among at least 10 firms that lifted price estimates for Deere in May, pushing projections to $72.71 a share, Bloomberg data show. That implies a 27 percent climb by May 2011 for the world’s biggest farm-equipment maker. Rising demand for tractors and combines led Moline, Illinois-based Deere to raise its annual profit and sales forecasts on May 19 for the second time this year.

Buying Opportunity

Steve Leuthold, who oversees $4.2 billion at Leuthold Group LLC, said the S&P 500’s 12 percent retreat since April 23 represents a “huge buying opportunity” in a May 20 report. The firm recently bought semiconductor stocks on speculation the shares are cheap relative to the industry’s earnings prospects, said Director of Research Doug Ramsey in an interview from Minneapolis.

“There’s no way the European debt problems are going to be enough to derail the growth that’s taking place in our economy and in Asia,” said Ramsey, who estimates the S&P 500 will rally at least 19 percent by year-end. “We’re in the camp that hasn’t revised down because of the pullback.”