By Arnie Kaufman
A new bull market arose out of the selling panic produced by the terrorist attacks. With stocks already deeply depressed, the concentrated dumping in mid-September finally exhausted downward pressure and allowed a recovery to gain traction.
The market turned just about when it should have relative to the economic cycle. According to S&P chief economist David Wyss, the recession will end in January or February. Stocks pulled out of their declines an average of four months before the end of the preceding nine postwar recessions.
Down markets don't last very long. In the past 60 years, the S&P 500 has never fallen three years in a row. In addition to 2000-2001, only 1973-1974 saw back-to-back declines, and that was followed by two years of double-digit gains.
The liquidity to fuel renewed economic expansion and market gains is high after a year of aggressive monetary easing by the Fed.
Household reserves, too, are substantial, with individuals holding a record $4 trillion-plus in money market funds and savings deposits. Part of this ultra-low-yielding money would be expected to flow back into stocks as confidence improves.
On average, a third of postwar bear market losses were recouped in the first three months of recovery. That's about what has been won back this time around. If the current advance continues to track its typical postwar predecessor, it will regain three-quarters of the bear market losses by the middle of 2002 and all of them by the end of 2002.
We're looking for decent progress, but a recovery of that magnitude may be asking a lot. One constraint: high stock valuations. Although the latest bear market was the second worst of the postwar period, price-earnings ratios remained elevated because earnings plunged as fast as prices. The earnings decline was particularly pronounced for big-cap technology and telecommunications services companies. Operating profits for the S&P 500 for 2001 are estimated to decline 28%. Without the tech and telecom firms, the drop would be 7%, says S&P sector strategist Sam Stovall.
Recovery in technology will lag behind the rest of the economy, so overall profit improvement in 2002 will be on the modest side. Earnings will be further inhibited by checks on companies' pricing power and by heavy spending on security. S&P analysts now see a 32% rise in earnings on the S&P 500 for 2002, but S&P research director Ken Shea says a third of this gain will come from a change in accounting for goodwill amortization.
The trauma caused by the bursting of the tech bubble will fade gradually, limiting the pace of the new market advance. While the S&P 500 slid 37% from March 2000 to September 2001, Nasdaq, home of most of the major tech stocks, fell 72%, the worst decline in its 31-year history.
Worries about possible additional terrorist attacks also make a headlong rush into stocks unlikely. And lots of overhead resistance must be dealt with, according to S&P chief technical analyst Mark Arbeter.
Our forecast is that the S&P 500 will reach 1255 by mid-2002 and 1315 by the end of 2002, for gains from the current 1123 of 12% and 17%, respectively. We see a similar rise for Nasdaq from 1953 now to 2205 and 2345.
Kaufman is editor of Standard & Poor's weekly investing newsletter, The Outlook