This is the first in our series examining the market predictions of some of Wall Street's top prognosticators. To see how Ed Yardeni's 2005 predictions fared, click here.

Who: Ed Yardeni

Title:

Chief Investment Strategist

Company:

Oak Associates

Quote:

"I'm quite optimistic for both the economy and the stock market in 2006."

Market Targets for 2006

S&P 500:

1410

Dow:

12000

Federal-Funds Rate:

5.0%

U.S. 10-year Treasury:

5.0% by spring and back down to 4.5% by year's end

Investment Picks
Buy: Within the energy sector Yardeni likes oil and gas drilling, exploration and production, and equipment and services companies. He also recommends commercial aircraft makers, financials and selected health-care industries including managed care, health-care supplies, health-care services and biotechnology.

Avoid: Automotive, advertising, media, broadcasting and materials.

Favorite Economic Indicators: Monthly productivity statistics and the consumer price index.

2006 Outlook
There's no need to fret about next year, says Ed Yardeni. Similar to his outlook for 2005, he anticipates benign inflation, impressive economic growth in the U.S. and abroad, strength in corporate earnings and solid stock-market returns.

Oak Associates' chief investment strategist expects the economy will expand at a rate of 3.5% next year and inflation will remain tame at around 2%. "With inflation at 2% the Fed will be hard-pressed to explain why it's raising interest rates over the next few meetings," he says. Yardeni puts the federal-funds rate at 5.0% by May, vs. 4.25% now.

What's driving his rosy outlook? Productivity. For the past 10 years productivity has increased at an annual pace of 3%, a trend Yardeni expects to continue over the next 12 months. At that rate, productivity will keep inflation low, profit margins high and drive the standard of living higher as workers' compensation increases. Indeed, productivity is the main force behind our standard of living, which he measures as the inflation-adjusted real compensation per worker. As it increases, so does consumers' purchasing power.

In this environment, Yardeni believes the stock market should easily appreciate 7% to 8% next year, in line with corporate earnings growth. There is, however, a good chance that it could do even better. If price/earnings multiples expand just 1%, which he thinks is a possibility as concerns over inflation decrease and investors conclude the Fed is near the end of its tightening cycle, then the major indexes should climb at least 10%. His year-end target for the S&P 500 is 1410; for the Dow Jones Industrial Average it's 12000, slightly higher than the Dow's all-time high of 11723 set on Jan. 14, 2000.

The one thing that could throw the market for a loop is geopolitics. Yardeni recommends watching for news on North Korea's and Iran's nuclear programs. Investor confidence could be tested if those situations come to a head in 2006. And, of course, a major terrorist attack is always a risk.

So where should investors park their money next year? One of Yardeni's major investment themes is that globalization should continue to boost international commerce and prosperity especially as the markets continue to be more integrated as free trade spreads.

If you agree with Yardeni's global theme, then you'll want to overweight the energy sector. "Prosperous people need more gasoline to get from point A to point B," he says. Within the energy sector, he likes oil and gas drilling, equipment and services, and exploration and production companies. Energy costs may have peaked, but at $55 to $65 a barrel, he says, oil prices are still high enough for these companies to turn handsome profits.

As people prosper, travel will increase, which Yardeni says will boost the need for more commercial aircraft. So too will commerce increase, which will lift demand for cargo planes. Already the long-term outlook for commercial aircraft demand is outstanding as Asian and Middle Eastern airlines expand and as air freight increases along with global trade, he says. Current aircraft backlogs suggest the good times could continue through the end of the decade.

Within the financial sector, Yardeni likes investment banks and asset managers. As international companies evaluate their businesses, management will look to sell off divisions that aren't profitable. This should be a boon for globe-trotting bankers. And now that people around the world are accumulating more wealth, they'll need banks to help them manage mounting assets.

Yardeni also favors some areas of health care. While he would avoid the troubled pharmaceutical makers, he likes biotechnology, managed health care, health-care services and health-care supplies. These industries are the clear winners now that a record 21% of total consumer spending goes toward medical goods and services.

What to avoid next year? Stay away from any business that's challenged by new technologies, especially the advertising, media and broadcasting industries. They're now competing with telecommunications, cable and Internet companies. While there's likely to be some consolidation in the affected industries, it's a tough investment game to play, Yardeni says.

If Yardeni's right, then there are lots of reasons for investors to look forward to next year. The key is to stay focused and buy into the groups that are well-positioned to benefit from global growth.