By Sam Stovall The current bull market just celebrated its third birthday. Back on Oct. 9, 2002, the Standard & Poor's 500-stock index posted a closing low of 776.76, which eventually marked the end to the bear market that began back in March, 2000, and erased 49% of its value. (S&P defines a bull market as an advance of at least 20% from the low set during the prior bear market.)
Since 1942, bull markets have lasted an average 56 months, or 4.5 years. From Oct. 10, 2004, through Oct. 7, 2005, the S&P 500 advanced 6.6%, which begs the question: Is this year's performance strong or weak?
During the first 12 months of a new bull market, the S&P 500 posted an average increase of 38%. Possibly of greater interest is that none of the industries in the S&P 500 posted an average decline during first-year bulls from 1968 to 2003. This phenomenon probably contributed to the genesis of the old Wall Street adage that a rising tide lifts all boats.
Second-year bull markets have also been pretty good to investors, since the S&P 500 rose an average 12% and recorded no declines.
A SECOND WIND? Third-year bull markets have been the most challenging for investors, in our view. In the past 60 years, the average price advance was only 3% during the third year of a bull market.
More important, however, was that six of the third-year performances were disappointments: One year the S&P 500 posted no change, while five times the market declined. And of those five declines, three became official bear markets shortly after. Therefore, since the S&P 500 gained 6.6% during this third year, vs. the 3% average, it looks like this was a pretty good performance.
History indicates that if the S&P 500 celebrates a third birthday without a decline, chances are very good that it will live to see its fourth birthday -- and even experience a growth spurt. There's no guarantee that history will repeat itself, but of the six surviving bull markets since 1942, the average fourth-year advance was 14% with only one decline -- which was less than 3%.
Source: Standard & Poor's
And what of sector performances? The table below highlights the performances of industries in the S&P 500 averaged to the sector level during the fourth year of bull markets since 1960, showing the average frequency that the underlying industries beat the S&P 500, their average price change (excluding dividends) during all periods, and during each of the five periods examined.
Source: Standard & Poor's
What we notice from the table above is that even though the S&P 500 advanced during a bull market's fourth year, investors played it safe and gravitated toward the defensive segments of the market. Consumer Staples and Health Care posted above-average price advances, as well as superior frequencies of outperformance. Technology issues also racked up a string of positive moves. This pronounced leadership, in our opinion, reflected investors' concerns surrounding the prospects of a slowing economy as a result of the Federal Reserve's likely rate-tightening program to thwart the threat of rising inflation.
Yet even during a resulting slower-growth period for the U.S. economy, we think investors believed that demand for the basics -- such as food, beverages, and medical care -- would remain fairly static, and the need for productivity-enhancing tools would also be favored by management.
The underperforming areas of the market -- energy, financials, materials, and utilities -- probably experienced attempted profit taking after having performed well as economic demand rose, or saw margins squeezed by a flattening yield curve as a result of the Fed's rate increases.
BUSINESS AT THE WHEEL. So what does S&P see for the coming year? The overall U.S. economy is projected to recover from the recent spike in oil prices brought on by Hurricanes Katrina and Rita as we head into 2006. And while the consumer is expected to continue supporting the economy's growth next year, business spending is seen as the main driver.
Inflation is projected to decline (after peaking in the 2005 fourth quarter) as oil prices are seen moderating. S&P expects crude oil prices to close 2005 at $65 per barrel and edge toward $54 by yearend 2006. Corporate earnings are projected to advance in the coming quarters, but at a decelerating rate.
S&P's Investment Policy Committee believes the S&P 500 will remain in bull-market mode into 2006, posting an increase of 5.1%, following a projected increase of 4.8% during 2005.
Industry Momentum List Update
For regular readers of the Sector Watch column, here's this week's list of the industries in the S&P 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 October 7, 2005.
Diversified Metals & Mining
Fertilizers & Agricultural Chemicals
Health Care Distributors
Health Care Services
Managed Health Care
Oil & Gas Drilling
Oil & Gas Exploration & Production
Oil & Gas Refining & Marketing
S&P STARS: Since January 1, 1987, Standard & Poor's Equity Research Services has ranked a universe of common stocks based on a given stock's potential for future performance. Under proprietary STARS (STock Appreciation Ranking System), S&P equity analysts rank stocks according to their individual forecast of a stock's future capital appreciation potential versus the expected performance of a relevant benchmark (e.g., a regional index (S&P Asia 50 Index, S&P Europe 350 Index or S&P 500 Index), based on a 12-month time horizon. STARS was designed to meet the needs of investors looking to put their investment decisions in perspective.
S&P Earnings & Dividend Rank (also known as S&P Quality Rank): Growth and stability of earnings and dividends are deemed key elements in establishing S&P's earnings and dividend rankings for common stocks, which are designed to capsulize the nature of this record in a single symbol. It should be noted, however, that the process also takes into consideration certain adjustments and modifications deemed desirable in establishing such rankings. The final score for each stock is measured against a scoring matrix determined by analysis of the scores of a large and representative sample of stocks. The range of scores in the array of this sample has been aligned with the following ladder of rankings:
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S&P Core Earnings: Standard & Poor's Core Earnings is a uniform methodology for calculating operating earnings, and focuses on a company's after-tax earnings generated from its principal businesses. Included in the Standard & Poor's definition are employee stock option grant expenses, pension costs, restructuring charges from ongoing operations, write-downs of depreciable or amortizable operating assets, purchased research and development, M&A related expenses and unrealized gains/losses from hedging activities. Excluded from the definition are pension gains, impairment of goodwill charges, gains or losses from asset sales, reversal of prior-year charges and provision from litigation or insurance settlements.
S&P 12 Month Target Price: The S&P equity analyst's projection of the market price a given security will command 12 months hence, based on a combination of intrinsic, relative, and private market valuation metrics.
Standard & Poor's Equity Research Services: Standard & Poor's Equity Research Services U.S. includes Standard & Poor's Investment Advisory Services LLC; Standard & Poor's Equity Research Services Europe includes Standard & Poor's LLC- London and Standard & Poor's AB (Sweden); Standard & Poor's Equity Research Services Asia includes Standard & Poor's LLC's offices in Hong Kong, Singapore and Tokyo.
In the U.S.
As of June 30, 2005, research analysts at Standard & Poor's Equity Research Services U.S. have recommended 30.2% of issuers with buy recommendations, 57.5% with hold recommendations and 12.3% with sell recommendations.
As of June 30, 2005, research analysts at Standard & Poor's Equity Research Services Europe have recommended 34.4% of issuers with buy recommendations, 46.8% with hold recommendations and 18.8% with sell recommendations.
As of June 30, 2005, research analysts at Standard & Poor's Equity Research Services Asia have recommended 33.3% of issuers with buy recommendations, 47.2% with hold recommendations and 19.5% with sell recommendations.
As of June 30, 2005, research analysts at Standard & Poor's Equity Research Services globally have recommended 31.0% of issuers with buy recommendations, 55.4% with hold recommendations and 13.6% with sell recommendations.
5-STARS (Strong Buy): Total return is expected to outperform the total return of a relevant benchmark, by a wide margin over the coming 12 months, with shares rising in price on an absolute basis.
4-STARS (Buy): Total return is expected to outperform the total return of a relevant benchmark over the coming 12 months, with shares rising in price on an absolute basis.
3-STARS (Hold): Total return is expected to closely approximate the total return of a relevant benchmark over the coming 12 months, with shares generally rising in price on an absolute basis.
2-STARS (Sell): Total return is expected to underperform the total return of a relevant benchmark over the coming 12 months, and the share price is not anticipated to show a gain.
1-STARS (Strong Sell): Total return is expected to underperform the total return of a relevant benchmark by a wide margin over the coming 12 months, with shares falling in price on an absolute basis.
Relevant benchmarks: in the U.S. the relevant benchmark is the S&P 500 Index, in Europe the S&P Europe 350 Index and in Asia the S&P Asia 50 Index.
For All Regions:
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Stovall is chief investment strategist for Standard & Poor's