Think about this: The S&P 500 is up nearly 10% from last year despite the country being at war, suffering the worst natural disasters in recorded history, seeing a record spike in oil prices, and absorbing 13 consecutive hikes in interest rates. This is some robust economy.

That’s how John Skjervem and Katherine Nixon of Northern Trust see it, and consequently they are bullish about stocks. They recently made a convincing case to clients that the economy is on track for solid but slower gains, and that stocks should continue to respond to growing earnings. It was the kind of presentation that trust companies are famous for – reassuring and not likely to send the blood pressure to unhealthy levels.

Mr. Skjervem, who serves as chief investment officer of Northern Trust, is forecasting 3% real GDP growth this year and continued moderate inflation. He expects, as do most economists, that the Fed will not raise rates above 4.5%. He’s also projecting that government spending to rebuild the Gulf Coast and a rise in exports to recovering economies will boost economic activity.

Bolstering his case are recent trends in the index of leading indicators, which point to growth, though at a lesser rate. The slowdown comes from the evident weakening of the housing market, which will dampen consumer spending. The lack of affordable housing has created demand and supply trends that are increasingly ominous. The housing market, as Mr. Skjervem points out, served as the nation’s ATM over the past several years, with homeowners extracting billions of dollars in equity-backed financings. This trend peaked in 2005, and is now heading sharply lower.

However, Mr. Skjervem is not predicting a consequent meltdown of the economy. Instead, he sees other areas gaining momentum, including capital investment, government spending, and exports. Importantly, these upturns are expected to persist in an environment of low inflation. Although commodity prices are tending to move sharply higher, other components such as labor costs, which weigh more heavily in the total mix, are recording only 3% year-over-year gains. Also, productivity, which has produced the biggest surprises in this cycle, is still running better than 3% ahead of year-earlier levels. As long as productivity stays ahead of wage gains, inflation will not become a threat.

Within this framework, a senior vice president of Northern Trust, Katherine Nixon, who is also a personal investment portfolio manager, expects earnings and stocks to perform well. Over the long term, corporate earnings have grown at 6.5%; this year, she is expecting earnings to expand at 10.5% to 11%.This projection is derived from the cumulative estimates of Wall Street analysts as well as from economists’ “top down” forecasts.

In 16 of the past 20 years, analysts have been overly optimistic about earnings. For the past three years, they have underestimated the impact of widespread corporate restructurings and have been too conservative. For 2006, analysts have become more aggressive and are forecasting that corporate earnings will increase nearly 13%.

Adding to Ms. Nixon’s positive outlook is that stock price/earnings multiples are at the lowest levels in 10 years. The last time the market sold at current valuations; the Fed Funds Rate was considerably higher, which would argue for lower prices. Another plus is the record level of corporate cash flow, which augurs well for capital spending. Industry has had six years to digest the capital spending spree of the late 1990s, and the need to update or replace equipment is kicking in.

Ms. Nixon said the high level of free cash will also spur stock repurchases and takeovers, both of which are positive for equity markets. And let’s not forget dividends. Dividend growth has picked up in the past three years and should continue.

Ms. Nixon is recommending “moderately” overweighting stocks today, while underweighting bonds. In particular, she likes the industrial sector and health care and energy issues. She would emphasize large capitalization and international names over small and midcap companies, and would prefer to move up the quality ladder. Oddly, stock valuations today are lined up in inverse relation to quality. Her preference for large cap stocks reflects their typically greater exposure to global growth, as well as cur rent valuation levels. Premiums paid for large cap names soared as the market came unstuck in the late 1990s, but have since collapsed. Specifically, P/Es of large cap companies hit a peak of 1.8 times those of smaller firms in 2000, and are now trading at only 0.88 times.

Similarly, despite better growth prospects, international stocks (in the EAFE index) are now selling at about the same P/Es as their domestic counterparts, rather than the substantial premiums of the mid-1990s.At the same time, earnings revisions by analysts covering foreign stocks are trending higher, especially in Japan and in Europe; stocks will likely follow. Ms. Nixon is especially positive on emerging markets, despite transparency and liquidity issues. She would recommend exchange-traded funds as the best way for individuals to participate in some of these arenas.

What can go wrong in this happy scenario? Plenty, of course, including a serious outbreak of avian flu, a worsening contretemps with Iran or, more likely, the Fed going too far and shutting down economic growth. The Northern Trust team also is concerned that Congress will not extend or make permanent the tax cuts instituted in 2003. Since those reductions, economic growth has motored along at better than 3%; prior to the cuts, the economy had been sputtering (even before September 11, 2001). Mr. Skjervem points out that despite the huge build-up in Iraq, the federal budget deficit has actually declined as a percentage of GDP, thus permitting the tax relief. On the other hand, he is quick to acknowledge that the great challenge confronting the government longer term is the ballooning of entitlements. That is not, however, a factor near-term.