Oct. 12 (Bloomberg) -- On Friday, the rally in the U.S. stock market turned seven months old.

The Standard & Poor’s 500 Index has returned 61 percent including dividends since the surge began on March 9. Some people now seem to believe that the advance has begun to fizzle, pointing out that the index hasn’t hit a new high since Sept. 22.

Let’s look at the anatomy of this bull market, and then move on to a prognosis about whether it’s likely to continue for another seven months or more.

Financial companies spearheaded the market rebound. From March 9 through Oct. 9, financial stocks in the S&P 500 rose 145 percent.

The financials, of course, got pounded during the bear market. While the broader indexes headed down for a year-and-a- half, financial stocks had a two-year bear market, beginning in the spring of 2007. Some of these stocks fell 90 percent or more.

As one Wall Street saying goes, “Even a dead cat will bounce, if you throw it off a skyscraper.” A key question for investors is whether the past seven months of action in financial stocks is merely a dead-cat bounce.

We’ve also seen strength in four other groups -- industrials, consumer discretionary, materials and information technology -- which have risen 70 percent to 75 percent since March 9.

These are all groups that one would expect to benefit from the end of a recession and the beginning of a recovery. Of course, back in March very few people saw any signs that a recovery was coming. As usual, the market saw it first.

Playing Defense

The traditionally defensive groups, so called because they usually hold up fairly well in market declines, have been weaker. Consumer staples, health care and utilities, are up 30 percent to 34 percent during the same period.

Energy has been a middling performer, up 37 percent. And telecommunications stocks have brought up the rear, advancing only 18 percent during the past seven months.

Commentators have said that this resurgence was led by low quality companies with weak earnings, heavy debt, or both.

My research supports the notion that companies with weak earnings have beaten companies with strong earnings.

I looked at returns for about 2,700 stocks in the 100 trading sessions through Oct. 7. I then measured which types of stocks did well. Among companies with scanty profits or none at all, 23 percent had gains of more than 58 percent. Among companies with high profits based on a return on equity of more than 20 percent, fewer than 7 percent did that well.

Investor Doubt

It looks as if investors had doubted the very survival of many struggling companies. Now, instead of valuing them under a yardstick of extreme fear, investors have gone back to valuing them under more normal criteria.

I found little difference in performance, though, between high-debt stocks -- those with debt equal to more than 100 percent of stockholders’ equity -- and those with debt of less than 1 percent.

Now, what about the future of the rally?

I feel fairly confident that the gains will chug along through at least the first quarter of 2010. In the past century, there have been 11 violent declines in the stock market, including the 2008-2009 disaster. In nine of the 10 previous cases, the ensuing rally lasted at least a year.

Historic Pattern

The historic pattern in rallies associated with economic recoveries is that about 40 percent of the gains occur in the first few months of the rally, while the recession still rages. About 60 percent of the gains occur during the recovery.

The early gains tend to be explosive. After the recovery is under way, gains generally come more slowly, over a one- to two- year period.

So far, I believe that the recovery and bull market are following this historic blueprint. Accordingly, I don’t agree with the school of thought that says the rally is petering out.

Stocks are little changed since the Sept. 22 high. They may even drop for a time, but I believe the overall direction still is up.

Here are three stocks that might do well over the coming 12 months, particularly if the economy perks up more and the rally rolls on well into 2010.

Three Picks

Oceaneering International Inc., based in Houston, provides goods and services to underwater oil and gas drillers. Among its products are remotely operated vehicles, or ROVs. It also has a contract to build spacesuits for the National Aeronautics and Space Administration.

The company has been profitable each year since 1999, and last year earned a record $3.65 a share excluding some items. This year analysts anticipate a 7 percent drop, to $3.38. The stock sells for about 16 times earnings.

URS Corp., with headquarters in San Francisco, is an engineering company with specialties in transportation and pollution-control facilities. Through a series of acquisitions, Chief Executive Officer Martin M. Koffel has built it up to $10 billion in sales. The stock seems attractive to me at less than book value (assets minus liabilities per share) and 0.35 times revenue.

Esterline Technologies Corp., located in Bellevue, Washington, makes controls for military and civilian planes, high-temperature-resistant materials, explosives and electronic warfare countermeasures. The stock is selling for less than book value and less than 11 times earnings.

Disclosure note: For clients and personally, I own shares of Oceaneering International and Esterline.

(John Dorfman, chairman of Thunderstorm Capital in Boston, is a columnist for Bloomberg News. The opinions expressed are his own. His firm or clients may own or trade securities discussed in this column.)

To contact the writer of this column: John Dorfman at jdorfman@thunderstormcapital.com.

Last Updated: October 11, 2009 21:00 EDT