Stocks, and valuations, may rise in 2007

By Chris Sanders

NEW YORK (Reuters) - If 2007 is another big year for U.S. equities, chances are it will bear one striking distinction from the first four years of the current bull market: stock valuations will rise along with stock prices.

Unlike what many might expect, while stocks have risen in the last four years, according to one of Wall Street's most widely followed valuation measures, price/earnings ratios have fallen as profit growth outstripped gains in stock prices. But P/E ratios are expected to rise next year as profit growth slows.

Since the S&P 500 .SPX began its climb in October 2002 on the heels of the post-Internet slump, it has risen 85 percent and is up more than 14 percent year-to-date.

Quarterly price-to-earnings multiples based on operating results, meanwhile, fell from 19.1 to 14.4 currently.

Top investors speaking at the Reuters Investment Outlook 2007 Summit in New York this week saw earnings growth falling by more than half from the double-digit gains of recent years down to the mid-single-digits, while share prices charge higher.

"I think profits (growth) will look much more like 5 to 6 percent," Robert Morris, chief investment officer with Lord Abbett & Co., said at the summit. He predicted the S&P will rise 10 percent.

John Gould, a portfolio manager with Schafer Cullen Capital Management in New York, said he sees about 4.5 percent earnings growth next year and a 10 percent market return.

"The balance of your return is going to come from a little bit of multiple expansion," he said.  Continued...