S&P's Sam Stovall on the one-year anniversary of the current bear market and when it might end
From Standard & Poor's Equity ResearchDuring the CB-radio craze of the 1970s, truckers would end their conversations with "10-4, good buddy." Today, however, Wall Streeters may begin adopting "10-9" as their cycle-ending mantra. Why? The bear market of 2000-02, which shaved 49.1% from the value of the S&P 500-stock index, ended on Oct. 9, 2002. The S&P 500 then entered into a new bull market, which lasted until Oct. 9, 2007, after gaining 101.5%.
Today, Oct. 9, 2008, we acknowledge that this bear market is now one year old and has cost us 37.1% of the value of the S&P 500.
At the Oct. 9, 2007, peak, the "500" stood at 1565.15. On Oct. 9, 2008, we started trading at the 984.94 level, and many are talking of a bear-market bottom. Before I weigh in on whether we are near the end of the third-worst bear market since World War II, and the fifth worst since 1929, let me remind you of where we've come and how it stacks up against the other bear markets over the past 80 years.
Not All Bear Markets Are Alike
This is the 15th bear market since 1929, according to S&P's Investment Policy Committee. We define a bear market as a price decline of 20% or more. I further refine bear markets into "Garden Variety," in which the S&P 500 slumped 20%-40% and "Mega-meltdowns," during which the S&P declined more than 40%. The reason for this distinction is twofold: price decline magnitude and time to recoup what was lost in the prior bear market.
Since 1946, the average time it has taken a "Garden Variety" bear to break even is 12 months. This relatively short time span is encouraging, in my opinion, and reminds us that while it is not smart to try investing next month's rent money, one needs to take advantage of—not run away from—stock market declines. "Mega-meltdowns" are another thing, mainly from the time required to recoup standpoint. Since World War II, it has taken us 63 months, or a little longer than five years, to get back all that we lost in the 1973-74 and 2000-02 bear markets.
I start with 1946, because if I started with 1929, the average would be skewed dramatically since it took us 25 years to get back to breakeven. Yes, the S&P 500 reached a high of 31.92 in September 1929, and it wasn't until September 1954 that it made it back to breakeven.
No Bottom Yet
Year to date through Oct. 8, the S&P 500 has fallen 32.9%. If this were the full-year performance, it would rank as the fourth-worst calendar-year decline since 1900, behind 1931 (-47.1%), 1937 (38.6%), and 1907 (-33.2%). What's interesting about the current bear-market decline is how it has emulated the averages. The current 37% peak-to-trough decline is close to the average decline of 38% for all bear markets since 1929. In addition, this bear market has taken back 74% of the prior bull market's point rise, which is a shade above the long-term average. Of course, we don't know whether we have established a bottom yet. Things could get worse before they get better. Finally, the sector alignment during this bear market closely emulates the average decline for all sector indices since 1990, and the average of all underlying sub-industries from 1946-1990.
During an average bear market since 1946 (including this one), the best performances have been recorded by the Consumer Staples, Health Care, and Utilities sectors. Except for the relative outperformance for the S&P 500 Energy sector this time around, the historical alignment of relative leadership has been replicated. The worst performances have typically been recorded by the economically sensitive Consumer Discretionary, Financials, Industrials, and Information Technology sectors. They have not disappointed us this go-round, either, as all have posted results that are worse than the S&P 500's. (The Telecommunications Services Sector has been in existence since the mid-1980s. Since then, it has posted a sharp decline during bear markets, and it has been true to its traditional underperformance this time as well.)
We can see, obviously, that from a sector level there is no place to hide. All sectors have posted average declines during bear markets. The defensive sectors—Consumer Staples, Health Care. and Utilities—have typically fallen less than the market as the demand for their products and services have remained fairly static. However, they should not be called "safe havens," in my opinion, since they don't rise during bear markets. During periods of equity market stress, cash remains king.
Easing Earnings Expectations
Since prices are typically a reflection of earnings, both reported and projected, it should come as no surprise that valuations have traditionally been highest at bull-market tops and lower near bear-market bottoms. (Actually, trailing price-earnings ratios have usually bottomed after stock prices have since investors are anticipators and typically buy back into the stock market when they suspect that the earnings picture will start to improve 6 to 12 months down the road.)
The S&P 500's p-e ratio on trailing 12-month GAAP (Generally Accepted Accounting Principles) or "As Reported" earnings per share historically peaked at 19.5. (I used the earnings that were reported for the quarter in which the market topped or bottomed, plus the trailing three quarters' actual results.) Bull market high-water marks were recorded in 2000 (at 30.0 times), 2007 (23.6 times), 1946 (22.9 times), and 1961 (22.8 times). On the flip side, five times since 1937, the S&P 500 saw a single-digit p-e ratio at bear-market bottoms. What's more, the average bear market's p-e of 12.3 times was 63% of the bull market's average. Today, we are looking at a p-e ratio of 16.5 times, based on the third-quarter 2008 "As Reported" EPS estimate, plus actual results for the fourth quarter of 2007 through the second quarter of 2008.
At 16.5 times trailing results, which is only 80 basis points above the average GAAP p-e ratio of 15.7 times since 1935, I don't believe this market is declining based on extended valuations as was the case in 2000. Many times, the p-e ratio was higher at bottoms. However, due to the global financial freeze-up and the expected negative impact on global economic growth, I think investors are disregarding bottom-up (analyst-generated) earnings per share estimates as not only being overly optimistic, but also unreliable.
Signs of Investor Panic
Regardless of current and projected EPS, an end to the bear market is traditionally gleaned from price action, rather than an actual improvement in fundamentals. Technicians also look to sentiment indicators to anticipate the initial bear-market bottom, and the likelihood of a successful retest. Since we have yet to record a possible market low on a closing basis, Mark Arbeter, S&P's Chief Technical Strategist, has been looking at several investor sentiment indicators for signs of excessive pessimism. He has found many, from put/call ratios to the overwhelming bearishness of newsletter writers. On Monday, Oct. 6, he noticed that New York Stock Exchange new lows divided by total issues traded spiked to almost 60%, which was an all-time high, and beat the 54% that was logged the day after the 1987 crash. He thinks this is clear evidence of panic by investors, which is another sign a bottom could be near.
Because stock indices have fallen off a cliff, he believes there is a chance that we see a large countertrend rally, as there is little chart resistance between the current level and 1,200 on the S&P 500. Taking Mark's cue, I have looked at the two-month average of daily high vs/ low percent changes in the S&P 500, and find that we have broken above the historical level of excessive volatility (which is measured by two standard deviations above the mean). This breakout is meaningful, in my view, since a peak in volatility, and bearishness, has occurred within one month of major bear-market bottoms since 1960.
In addition, currently 98% of all subindustries in the S&P 500 have declined in the past six months, equaling the extreme bearishness seen on Sept. 27, 2002, which occurred within two weeks of the eventual bottom of the 2000-02 bear market. Of course, records are meant to be broken, and there is no guarantee that what worked in the past will work again in the future. But if we are attempting to answer the question, "Is it too late to get out of stocks?" History would say "Yes."
The Risk of a Global Recession Remains
It doesn't mean that worries about the global economy and corporate earnings will dissipate anytime soon. David Wyss, S&P's Chief Economist, just updated his U.S. economic forecast and his prognostication has gotten a bit gloomier. He now forecasts three successive quarters of real gross domestic product decline here in the U.S. before emerging from recession. Even though the U.S. Congress passed the Troubled Assets Relief Program (TARP) on Oct. 3, financial markets did not see it as a panacea. We think investors will need to see TARP in action before they begin to believe it will work and initiate a recovery in share prices.
Third-quarter 2008 earnings for the S&P 500 started on a less-than-uplifting note. Third-quarter results are expected to be soft once again, and guidance is not likely to be forthcoming in quantity or detail. S&P equity analysts expect the S&P 500 to post a decline of 2.6% in the third quarter and a full-year falloff of 7.0%. Early estimates for 2009 look optimistic, for a full-year advance of 35%. For 2009, all 10 sectors in the "500" are projected to post year-over-year increases in operating results, with the biggest gains coming from Consumer Discretionary and Financials, the two sectors that took a beating in 2007 and are likely to repeat their poor showing in 2008.
Excluding the more than 400% jump in EPS expected for the Financials sector in 2009, we arrive at a more muted 16% year-over-year climb in operating results for the S&P 500.
Any way you look at it, we think prices will likely turn higher before the economy or earnings do. As a result, S&P recommends sitting tight. Don't sell remaining equity holdings, but maintain a defensive posture with sectors as we look for additional signs of a bear-market bottom.