During 2004, this subindex underperformed the broader market, rising 3.9%, while the S&P 1500 advanced 10%. But 2005 tells a different story: Year to date through Oct. 14, this subindustry index gained 3.8%, while the overall market fell 1.6%.
"STEEP DISCOUNT." The rolling 12-month relative-strength price chart (pictured below) demonstrates this recent outperformance. As a reminder, the jagged blue line represents the subindustry index's rolling 52-week price performance vs. the 52-week performance for the S&P 1500. Any point above 100 indicates market outperformance over the prior year, while points below 100 indicate market underperformance. The red line represents a rolling 39-week moving average, while the two green bands indicate one standard deviation above and below the subindustry index's 14-year mean relative strength.
To determine whether this market leadership has a good chance of continuing, I checked with Robert Hansen, S&P's Investment Banking & Brokerage analyst. He says S&P has a positive fundamental outlook on the subindustry. He also indicates that S&P believes current valuations on the stocks look attractive, especially for the larger companies, with the group trading at a steep discount to the S&P 500, and near its 10-year historical average p-e multiple.
But S&P thinks industry stocks should trade at premium multiples, based on what it sees as generally improving investor confidence and economic conditions. Hansen expects increased profitability as higher-margin equity-capital markets, mergers and acquisitions, and merchant-banking activity rise from cyclically depressed levels. In addition, S&P expects continued growth -- although with volatility -- in commission revenues, customer margin lending, and merchant banking.
FAVORABLE ATTITUDES. Hansen points out that S&P's enthusiasm is tempered somewhat by its concerns about rising interest rates, a flattening yield curve, and potentially widening credit spreads, which it expects to hurt fixed-income underwriting and proprietary-trading revenues in 2006.
But according to Hansen, S&P is impressed that the industry has managed to grow profits in recent years. This results in part from its highly variable cost structure, in his view. S&P believes stock-market gains in recent years have contributed to generally improving investor confidence, resulting in higher capital-markets activity, commission revenues, and asset-management fees.
S&P expects a rebound in equity-oriented corporate-finance activity, based on its view of healthy market conditions. Hansen says S&P also expects the fixed-income market to remain resilient in light of a shift toward adjustable-rate mortgages, and continued investor demand for higher-yielding securities, despite a potentially flatter yield curve.
WILL PROMISE PERPETUATE? In light of improved profitability, Hansen expects companies to increase head count and compensation over the next few years, while maintaining operating leverage. S&P sees increased price competition among brokerage firms, and expects online discount brokers to continue to take market share from full-service brokers.
Based on an anticipated cyclical rebound, S&P views the industry's longer-term outlook as favorable. Hansen says S&P thinks that earnings will continue to grow, aided by what it views as prudent compensation-expense growth, despite a potential slowing in fixed-income originations.
So there you have it. In S&P's view, the subindustry's momentum and fundamental outlooks are both favorable, indicating that it believes this group will turn into a market outperformer in the months to come. Among S&P's top selections in the group: Goldman Sachs (GS
) and Bear Stearns (BSC
), each ranked 5 STARS (strong buy).
Source: Standard & Poor's
Industry Momentum List Update
For regular readers of the Sector Watch column, here is 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 Oct. 14, 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:
S&P Issuer Credit Rating: A Standard & Poor's Issuer Credit Rating is a current opinion of an obligor's overall financial capacity (its creditworthiness) to pay its financial obligations. This opinion focuses on the obligor's capacity and willingness to meet its financial commitments as they come due. It does not apply to any specific financial obligation, as it does not take into account the nature of and provisions of the obligation, its standing in bankruptcy or liquidation, statutory preferences, or the legality and enforceability of the obligation. In addition, it does not take into account the creditworthiness of the guarantors, insurers, or other forms of credit enhancement on the obligation. The Issuer Credit Rating is not a recommendation to purchase, sell, or hold a financial obligation issued by an obligor, as it does not comment on market price or suitability for a particular investor. Issuer Credit Ratings are based on current information furnished by obligors or obtained by Standard & Poor's from other sources it considers reliable. Standard & Poor's does not perform an audit in connection with any Issuer Credit Rating and may, on occasion, rely on unaudited financial information. Issuer Credit Ratings may be changed, suspended, or withdrawn as a result of changes in, or unavailability of, such information, or based on other circumstances.
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 September 30, 2005, research analysts at Standard & Poor's Equity Research Services U.S. have recommended 28.7% of issuers with buy recommendations, 60.3% with hold recommendations and 11.0% with sell recommendations.
As of September 30, 2005, research analysts at Standard & Poor's Equity Research Services Europe have recommended 34.8% of issuers with buy recommendations, 44.8% with hold recommendations and 20.4% with sell recommendations.
As of September 30, 2005, research analysts at Standard & Poor's Equity Research Services Asia have recommended 28.1% of issuers with buy recommendations, 51.1% with hold recommendations and 20.8% with sell recommendations.
As of September 30, 2005, research analysts at Standard & Poor's Equity Research Services globally have recommended 29.3% of issuers with buy recommendations, 57.7% with hold recommendations and 13.0% 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:
All of the views expressed in this research report accurately reflect the research analyst's personal views regarding any and all of the subject securities or issuers. No part of analyst compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed in this research report.
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Readers should note that opinions derived from technical analysis might differ from those of Standard & Poor's fundamental recommendations. Stovall is chief investment strategist for Standard & Poor's