NEW YORK-The market has the potential to perform well next year, better than this year, as the pre-presidential election cycle begins, the Federal Reserve has been pausing rates and investor confidence is high, all factors that could influence next year, experts say.

"We are in a relatively good environment. The market is not too cheap or too expensive," said Brian Posner, chief executive officer and co-chief investment officer ClearBridge Advisors, a division of Legg Mason, at the 13th annual Legg Mason Symposium here last week.

The stock market should rise significantly next year as the Fed has not raised rates, inflation remains low, corporate buyback activity is at record levels, as is buyout activity, and the economy is solid and earnings growth has been strong, said Bill Miller, chairman, chief investment officer and portfolio manager of Legg Mason Capital Management.

Miller is best known for his Legg Mason Value Trust Fund beating the Standard & Poor's 500 Index every year for the past 15 years. However, this year, the $20.7 billion portfolio's streak will likely end.

Equities tend to move in the same direction as earnings, just not always at the same pace and speed of earnings, Miller said. "We are in the midst of a mid-cycle slowdown, not an economic cycle, but a mid-Fed cycle, which historically has benefited large-cap companies," said Miller.

Large-cap growth funds are poised for a comeback next year, and even the poorest performing funds will see improvement, said Curtis Teberg, portfolio manager of the Teberg Fund, in an interview separate from the symposium. Historically, large-cap growth funds have had an average return of 11% in the first quarter of the year preceding a presidential election, which is the current quarter of this year, Teberg said.

Since 1951, the only time large-cap growth funds did not perform well in the first quarter of the pre-presidential election cycle was in 2003, but the funds ended up having a great year anyway, Teberg said. Large-cap growth funds have already seen improvement in the past 60 days, he added.

Mid-cap growth funds may also see improved results, as these funds typically have 13% returns in the first quarter of the pre-presidential election cycle, Teberg added.

Among sectors that performed poorly this year were healthcare and homebuilders, both of which Miller had in his portfolio. Healthcare performed relatively poorly due to a number of scandals at companies, such as United Healthcare, exacerbated by the stock options scandal, Miller said.

Also, healthcare companies have outperformed the market in the last five years, so they are taking a breather, he said. Miller feels the group is undervalued and will perform better next year.

Healthcare stocks might also be impacted by the pre-presidential election cycle, as the sector normally posts 5% returns during the first quarter, but during a pre-presidential election year, the first quarter has average returns of 13%, Teberg stated.

Aspects of the energy sector can still be attractive next year as well, experts said. The energy sector may see opportunities among companies that extract the oil from the ground, Posner said. Broad technology and Internet companies are poised for a comeback next year, as well, Miller said.

The market can be viewed in terms of what stocks performed poorly this year, experts noted, as the cyclical nature of the markets tends to make them do well in the following year. "All sectors have good stocks in them, and the industries need to be searched to find the value stocks," said Neil Hennessy, president and portfolio manager of Hennessy Funds, also in an interview following the symposium.

It is better to take a specific stock approach to investing rather than a broad market or sector call, said Richie Freeman, portfolio manager of aggressive growth at ClearBridge Advisors. "Markets typically fool people," he said.

The Dow Jones Industrial Average could surpass 14,000 next year, experts said. Historically, in the third year of a president's term, market averages gains of 23%. Twenty-three percent from where the market is now is 4,000 points, he said.

"We are at an historically low unemployment rate. Inflation and interest rates are low. Corporate profits have increased 10% to 25%. Balance sheets are at $2 trillion, and investor confidence is up-all factors which could push the market higher," Hennessy said.

Internationally, investors are starting to realize that emerging markets are no longer dirt cheap, said Jim Hodge, president and chief investment officer of Permal Asset Management, another Legg Mason subsidiary. "The beta ride is over, and now investors have to go to for alpha."

In Japan, where a lot of hedge fund money went this year, companies will start to hire small-cap managers, Hodge predicted. In Europe, there will be growth challenges in alternatives, he said.

Also, Thailand is a popular area, but it is not that large, so there is not a lot of investing one can do there, Hodge added.

Regarding China, the potential is phenomenal, but investors should remain somewhat cautious, experts agreed. Typically, it takes quite a while to transform an economy, and retail investors are five to 10 years away from seeing rewards in the area, said Ken Leech, chief investment officer of Legg Mason subsidiary Western Asset Management.

During the first quarter of the pre-presidential election year, world stock funds return an average of 10%, Teberg said.

"Next year should be a good year, and you don't have to be brilliant to do well," Hodge said.

(c) 2006 Money Management Executive and SourceMedia, Inc. All Rights Reserved.

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