If It Runs Like a Bull...


By Sam Stovall Is history repeating itself? In the nearly 12 months since the Standard & Poor's 500-stock index touched a bear-market closing low of 776.76 on October 9, 2002, the 500, as well as its underlying sectors and industries, has recorded price gains that are strikingly similar to average increases posted during the first 12 months of previous new bull markets since 1970. These performances, along with S&P's expectations for stronger U.S. economic growth and a corresponding rebound in corporate earnings, reinforce our optimistic outlook for the equity markets through 2004.

In less than a month, the bull market of 2002-03 will celebrate its first birthday. While many investors may still claim that the S&P 500 is seeing nothing more than a rally within a bear market, Mark Arbeter, S&P's chief technical analyst, has noted several characteristics of the current recovery -- only a few of which are noted here -- that are consistent with market bottoms since 1970. Together, these similarities in key technical indicators led him to the conclusion that a new bull market has begun:

At a bottom, the S&P 500 usually evidences some type of major reversal formation, such as a

double bottom, indicating substantial support at that level, and that the index should not break through to a new low. This time the index flashed an even stronger signal: A triple bottom.

The S&P 500 broke strongly above its bear-market

trendline, which had contained prices during the entire equities downturn.

All bull markets have begun with a noticeable pickup in trading volume. In some cases, volume exploded. So far, a increase has occurred -- but well below the levels of the other bull runs.

In summary, while this bounce off the bottom has been on the tepid side when compared with prior market rebounds, Arbeter believes substantial evidence exists that it's for real.

So, if indeed the Street is closing in on the first year of a new bull market, how has the S&P 500's recent performance compared with prior first-year bulls? Take a look at the table below, which shows average price changes during the first years of the six bull markets since 1970 (including the current one), performances during this new bull market, and average changes during the second years of bull markets (this group has data for only five years, since year two of the current upswing is yet to come) for key sectors and indexes since 1971.

Bull Market Performances 1970 - Mid-September 2003 (% change)

Sectors/Indexes

1st Yr. Avg.

Current Bull

2nd Yr. Avg.

S&P 500

37

33

14

S&P 500 Growth Group

27

28

13

S&P 500 Value Group

30

38

13

Small-Cap Stocks

52

32

4

NASDAQ

54

56

9

Consumer Discretionary

53

36

15

Consumer Staples

37

1

20

Energy

32

17

13

Financial

38

38

17

Health Care

29

13

11

Industrials

37

36

13

Information Technology

37

75

9

Materials

33

39

5

Telecommunications Services

9

28

29

Utilities

20

42

10

During the first year, three factors become apparent about the market indexes. First, performances for each of the major benchmarks were very strong, which may be reassuring to investors who are concerned that stock prices have come too far, too fast. Second, the order of outperformance: The NASDAQ usually puts in the best first-year gain, followed by small-cap stocks, large-cap issues, and the value and growth components of the S&P 500. The final observation is that historically, a rising tide truly does lift all boats -- consistency of performance appears to be a hallmark of early bull markets.

WHAT'S AHEAD? This time around, we find it remarkable that the performances for the S&P 500, its growth and value subindexes, and the NASDAQ composite index were very close to the average performances for first years of new bull markets. Only small-cap stocks appear to have posted a subpar comparative performance since October, 2002. That might have happened because the S&P SmallCap 600 held up so well in the most recent bear market, falling only 10% from the top in March, 2000, through the end of September, 2002, while the S&P 500 gave back more than 49% during that same time.

On a sector level, we see that on average most do well, led primarily by the economically sensitive groups. This time around, the economically sensitive Consumer Discretionary, Information Technology, and Materials sectors are again posting strong results.

What might an investor look forward to in the second year of a bull market? Column three of the table shows that while the market indexes historically continued to post returns that were above their long-term averages, their second-year improvements were much less dramatic -- and much less consistent -- than during the first years. In addition, we see that the S&P 500 takes a leadership role, outpacing the small caps and NASDAQ, which appear to have taken a breather from their first-year sprint.

GUIDE, NOT GOSPEL. In terms of sectors, the consumer remained king, as investors piled into of Consumer Discretionary and Staples issues. In addition, Financials and Industrials also maintained leadership positions as economic demand increased. Even though Telecom Services shares posted strong results in the first year, they lacked staying power -- the group participated in only two of five second years of new bull markets.

Consistency also appears to have declined. While no sectors or industries posted declines on average during the first year of bull markets, the second year saw a noticeable increase.

Will the second year of this bull market perform in line with the average of prior bull markets? Possibly, but we would look upon history as a guide and not gospel. And while S&P believes the market indexes may post results that are similar to prior performances, sector outcomes may be a bit different.

ELEVATED TARGETS. On Sept. 4, S&P's

Investment Policy Committee -- a group of senior managers who meet weekly to oversee all investment-related activity done in S&P's name -- elected to increase the yearend 2003 target for the S&P 500 index to 1,085 from 1,030, anticipating a 23% full-year price rise for the index. S&P cited the accelerating economy, rising earnings projections, and historical precedent as factors contributing to the elevated target. The 2004 target was established at 1190, indicating an expected 10% gain for that year.

S&P projects that the U.S. economy will keep rebounding, benefiting from the massive fiscal and monetary stimulus being pumped into the system. We see real gross domestic product advancing 2.7% in 2003, followed by a 4.7% jump in 2004, and a closer-to-trend growth of 3.7% in 2005. S&P also projects operating earnings for the 500 to rise 17% in 2003 and 13% in 2004, resulting in a yearend 2003 price-earnings ratio of 20, which is equal to the average since 1988.

Unlike during past rebounds, however, S&P now recommends that investors overweight Consumer Discretionary, Health Care, and Information Technology in their portfolios. Energy, Financials, and Materials have a marketweight recommendation, while Consumer Staples, Industrials, Telecom, and Utilities are designated underweight. Here's a rundown of our outlook for the S&P sectors:

Sector

Investment Outlook

Consumer Discretionary

A likely beneficiary of still-strong housing, effective merchandising, and/or favorable cash flow.

Consumer Staples

Reduced earnings expectations and increasing investor emphasis on growth-oriented stocks.

Energy

A buildout of global oil and U.S. natural gas inventories may be offset by peaking earnings.

Financials

The effects of lower interest rates are being offset by credit quality concerns.

Health Care

We see sector fundamentals comparing favorably with the overall domestic economy.

Industrials

Negative fundamental outlooks for leading subindustries, such as aerospace and machinery.

Info. Technology

We expect a cyclical improvement, due to an improving U.S. economy and low interest rates.

Materials

Selected issues may benefit from a recovering economy, but the sector should track the market.

Telecom Services

Sales, earnings, and credit-rating trends should continue to pressure these issues.

Utilities

Earnings-per-share growth may be restricted by rising labor and insurance costs.

In summary, while S&P is optimistic toward the markets as a whole and thinks they'll perform in line with historical precedent, our sector recommendations differ from past patterns due to our view of a unique economic backdrop and sector-specific factors. Besides, it's worth repeating: We treat history as a guide, not gospel.

Industry Momentum List Update

For regular readers of the Sector Watch column, here's this week's list of the 11 industries in the S&P Super 1500 with Relative Strength Rankings of "5" (price performances in the past 12 months that were among the top 10% of the industries in the S&P 1500) as of Sept. 19, 2003.

Industry/Sector

Company

S&P STARS* Rank

Communications Equipment/Info. Tech

Cisco Systems (CSCO)

5 STARS

Computer & Electronics Retail/Consumer Discretionary

Best Buy (BBY)

5 STARS

Computer Storage & Peripherals/Info. Tech.

Storage Technology (STK)

4 STARS

Constr., Farm Mach. & Heavy Trucks/Industrials

Caterpillar (CAT)

3 STARS

Consumer Electronics/Consumer Discretionary

Harman International (HAR)

Not Ranked

Diversified Metals & Mining/Materials

Phelps Dodge (PD)

3 STARS

Internet Retail/Info. Tech.

eBay (EBAY)

3 STARS

Internet Software & Services/Info. Tech.

Yahoo! (YHOO)

3 STARS

Semiconductor Equipment/Info. Tech.

ATMI (ATMI)

5 STARS

Semiconductors/Info. Tech.

Intel (INTC)

5 STARS

Wireless Telecom Svcs./Telecom Svcs.

Nextel (NXTL)

5 STARS

* S&P's stock appreciation ranking system for the coming 6- to 12-month period: 5 STARS (buy), 4 STARS (accumulate), 3 STARS (hold), 2 STARS (avoid), 1 STAR (sell). Stovall is chief investment strategist for Standard & Poor's


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