S&P 500 Dregs Stage Uprising in Bull Market That Now Makes Sense

Stocks Climb Toward Fresh Record: Can the Rally Last?
  • Cyclical shares with high beta beating defensives in rally
  • How the 14-month dry spell that just ended compares with past

From last week’s confluence of record highs to rebounding growth stocks, there’s a lot to like in a market as hated as this one.

No longer are low-volatility stocks the leaders. Nor are utilities, or companies that sell toothpaste and handsoap. Nary a defensive share is rallying as leadership in the S&P 500 Index switches from the dividend-paying bond surrogates that ruled 2015 to technology, banks and commodity firms that benefit from an expanding economy.

One interpretation is that the rotation was inevitable. Another is that the shifting tides are the start of something big, a sign that investors have survived a 14-month catharsis that was in many ways identical to a bear market. More than half the S&P 500’s companies fell more than 20 percent between May 2015 and last month.

“The market has been in a kind of an internal digestion period for more than a year where you’ve had rotation but overall not a lot of progress,” said Marshall Front, who oversees $800 million as chief investment officer at Front Barnett Associates LLC in Chicago. “Now you’re starting to see a breakout that may be the end of this rotation that kept the market within range.”

Slow but steady gains in the S&P 500 have lifted the benchmark 9.2 percent since the two-day rout following Britain’s secession vote on June 24. Computer and software makers, financial firms and industrial companies have all climbed at least 9.7 percent, while utilities declined. The S&P 500, Dow Jones Industrial Average and Nasdaq Composite Index simultaneously rose to all-time highs last week for the first time since 1999. Futures on the gauges were little changed at 10:48 a.m. in London.

The rally is straining the main case of the bears, which boils down to an observation that the bull market that began in March 2009 has gone on for too long. At 90 months, the rally is now the second-longest in American history, sputtering along amid a lengthening list of threats that include a five-quarter decline in corporate profits, swelling valuations and the first Federal Reserve rate increase in a decade.

Along the way have been stretches that would shake anyone’s confidence, most memorably the rout that accompanied the European debt crisis in 2011 and sent the S&P 500 within 9 points of a 20 percent swoon. Another was the season of futility that ended in July, when the benchmark index went 14 months without a record and twice slumped more than 10 percent -- including in January, the worst start to a year ever.

An argument is now being made that those declines did enough damage to sentiment to set the stage for more gains, chasing out investors who will be forced back in as equities rally. In particular, data compiled by Bloomberg show, the most recent downdraft was a much bigger shock than is usually recognized.

More than half of S&P 500 companies have endured bear markets the past year, the data show. Over the 417-day period from May 2015 to July 8 that saw the market fluctuate, plunge, rally and ultimately flatline, 269 shares fell at least 20 percent and never fully recovered their losses.

While the index itself never got close to the 20 percent loss threshold that qualifies as a bear market, the number of declines of that size in individual companies was virtually the same as in 2011, when the benchmark gauge plunged more than 19 percent and the bull market was preserved in name alone.

“It speaks to a very balanced market advance that we’re having these corrections and bear markets in companies and sectors as we go along,” David Kelly, chief global strategist at JPMorgan Asset Management, said in an interview. “It’s in the short run bullish. The resilience of this bull market is built to some extent on the fact people have been in their own bear markets in their companies and that we’ve had corrections along the way.”

Investors have pulled almost $80 billion from U.S. equity mutual funds in 2016, according to Investment Company Institute data. Stocks have been shunned this year even as the major indexes set new highs. Exchange-traded funds tracking equities have seen just $28 billion in inflows, compared with $73 billion in fixed income funds, data compiled by Bloomberg show.

And even as hundreds of stocks slipped into their own private bear markets, it hasn’t been enough to stop equity valuations from climbing. At 20.5 times trailing 12 month profits, the S&P 500 is the most expensive since 2009. The ratio of price to earnings before interest, taxes, depreciation and amortization sits just below a record reached before the dot-com bubble burst.

Company profits, in their fifth straight quarter of year-over-year declines, are set to fall again in the next reporting season, according to analysts surveyed by Bloomberg. That’s sent the S&P 500’s multiple up at a faster pace than the index itself, climbing 9.5 percent in 2016. The index price is up just 6.9 percent.

At the same time, U.S. economic reports have been better than forecast. The Bloomberg Economic Surprise index turned positive on July 12, meaning data has beaten Wall Street expectations. Stocks closed at a record last week on the back of an employment report that showed U.S. employers added 255,000 jobs in July. Payrolls have shown strong gains for two months and wage increases are slowly accelerating, giving consumers more confidence and power to spend.

Amid that backdrop, companies seen as havens from economic duress have become the stock market’s worst performers. Utilities, phone companies and staples have lagged behind, adding no more than 3.7 percent since June 27.

“The market kind of washed out from a micro basis,” Stewart Warther, an equity strategist at BNP Paribas in New York, said by phone. “Once you have this readjustment and economic expectations start to turn, investors start looking for historically low valuations, which right now encompass energy and financials sectors.”

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