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Market Update

The Year in Stocks: The Rally Continues

Year-end surge pushes equities firmly into positive territory.

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Stocks are ending 2005 with a surge, pushing all the Morningstar diversified equity categories firmly into positive territory. Mid-caps and energy-related issues are leading the way, and growth stocks are showing signs of life. The rally in equities continued for the third straight year after the bursting of the technology bubble sent stocks reeling from 2000 through 2002. The Morningstar U.S. Market Index rose 6.4% for the year through Dec. 21, putting on about 3% in the final quarter.

The market shrugged off debt downgrades at automaker  General Motors (GM), legal troubles and weak research pipelines at pharmaceuticals  Merck (MRK) and  Pfizer (PFE), struggling traditional media and newspaper stocks  Time Warner (TWX) and  Dow Jones (DJ), and airline and auto-parts bankruptcies. Difficulties at these businesses meant good news for rivals such as  Toyota (TM),  Google (GOOG), and  Genentech (DNA). Additionally, mergers, acquisitions, and restructurings also supported equities. Among the bigger announcements and consummations were SBC/ AT&T (T),  Procter & Gamble (PG)/Gillette,  Chevron (CVX)/Unocal, and  ConocoPhillips (COP)Burlington Resources (BR). Notable spin-offs included  Expedia (EXPE) (from  InterActiveCorp (IACI)) and CBS (from  Viacom (VIA.B)). Morningstar analysts currently view Google as overvalued, but find newspapers and both InterActiveCorp and Expedia attractive.
While influential financiers sometimes instigated these corporate events, legendary investor Warren Buffett characteristically remained content to leave the managers of his holdings alone. His company  Berkshire Hathaway (BRK.B) picked up shares of brewer  Anheuser-Busch (BUD), home improvement retailers  Home Depot (HD) and Kingfisher PLC, computer-printer maker  Lexmark (LXK), and industrial conglomerate  Tyco (TYC). Analyst Dreyfus Neenan views Berkshire as a bargain currently.
Equity markets also mostly ignored political and macroeconomic problems such as continued difficulties in Iraq, the "twin" budget and trade deficits, surging oil prices, the Federal Reserve's interest rate raising campaign, and the destruction wrought by Hurricane Katrina. Bonds, however, finally felt some of the Fed's pressure as they struggled to eke out gains, with the Lehman Brothers Aggregate Index up a modest 1.91% through Dec. 21. Nevertheless, a "flat" yield curve (little difference between short-term and long-term yields) bespeaks their continued resilience, which is keeping the housing market humming. Alan Greenspan's successor, Ben Bernanke, will have to manage this, as he seeks to curb inflation without halting growth. Homebuilding stocks such as  Toll Brothers (TOL),  Pulte (PHM), and  Centex (CTX) suffered a fourth-quarter swoon, but still tacked on healthy gains for the year. None remains in 5-star territory.

John Coumarianos has a position in the following securities mentioned above: MSFT, DEO, BRK.B, TRP. Find out about Morningstar’s editorial policies.

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