Happy Birthday, Bull Market!

S&P's Sam Stovall says Oct. 9 was its first anniversary -- and he sees more gains coming, even if there's a slight pullback

It's a bull market -- and it celebrated its first birthday on Oct. 9. That's the word from Sam Stovall, chief investment strategist for Standard & Poor's. Stovall notes that in the first year of bull markets since 1945, the S&P 500-stock index gained 38%, but this time the increase is 34%. Looking ahead, Stovall says S&P's investment policy committee sees the 500 ending 2003 up 23% at 1085, with an additional 10% rise in store for 2004. However, he adds that a slight pullback is "not out of the question" in the coming months.

Meantime, he reports that S&P has recently added to its 5-STARS (buy) list ImClone (IMCL ), Abercrombie & Fitch (ANF ), and Automatic Data Processing (ADP ). With investors closely watching how corporate earnings come in, Stovall says S&P anticipates a 17% increase in that crucial figure for the full year of 2003, with a further 13% improvement coming in the year ahead.

These were some of the points Stovall made in an investing chat presented Oct. 14 by BusinessWeek Online and S&P on America Online, in response to questions from the audience and from BW Online's Jack Dierdorff. Edited excerpts follow. A full transcript is available from BusinessWeek Online on AOL at keyword: BW Talk.

Note: Sam Stovall is a registered representative of Standard & Poor's Securities, Inc. He has no affiliation with or ownership interest in any companies under discussion. Other S&P affiliates may provide services to the companies under discussion.

Q: Sam, the S&P 500 is healthily in four digits, and the NASDAQ is pushing 2000 -- do you see the bull running yet?


Do I see the bull running YET? In our opinion, a bull market started its run back on October 9, 2002, and just celebrated its first birthday on October 9, 2003.

If your question, however, was "Do I think this bull still has legs?" I would point to history and say that in the first year of bull markets since 1945, the S&P 500 has advanced an average of 38%. This time around, we gained 34%. The S&P would have to have reached 1070 in order to have advanced by an equal amount of 38%. S&P's investment-policy committee believes the S&P 500 will end 2003 at 1085, for a 23% full-year gain, followed by an additional 10% advance in 2004, closing at 1190.

Q: Do you see corporate earnings continuing to come in well as announcements proliferate?


Yes. S&P's equity analysts, as a whole, project a 19% year-over-year increase in operating earnings for the quarter that just ended and see a 21% rise likely for the fourth quarter of this year, resulting in a 17% full-year increase. We also expect earnings to rise an additional 13% in 2004.

Q: O.K. What's the top stock?


Well, I will attempt to accommodate by giving a list with the word "top" in it. This is the S&P Top 10 list, consisting of companies with 5-STARS (buy) rankings by S&P analysts. A company receives a 5-STARS ranking when the S&P analysts believe that the shares offer a 20%+ price appreciation potential in the coming 12 months.

The stocks that currently are found on this Top 10 list are Flextronics (FLEX ), Martek Biosciences (MATK ), Intrado (TRDO ), Comcast (CMCSA ), D.R. Horton (DHI ), Fair Isaac (FIC ), Corinthian Colleges (COCO ), Intel (INTC ), Compass Bancshares (CBSS ), and Jacobs Engineering Group (JEC ). Year-to-date, through Sept. 30, while the S&P 500 advanced 13.2%, S&P's 5-STARS stocks rose 18.7%, and the S&P Top 10 list gained 26%.

Q: IBM (IBM ) for two to three years, please?


The best I can offer you on IBM is guidance over the next 12 months, because that's how S&P analysts evaluate equities. IBM currently carries a 5-STARS or buy ranking.... In addition, S&P's sector group head, in concert with the analysts who make up the IT sector, recommend that investors overweight their exposure to the technology sector because of improving earnings and investor interest. We currently have buy recommendations on 20 technology issues -- the greatest number of 5-STARS in any of the sectors within the S&P 500.

Q: Outlook for Pfizer (PFE )?


We have a 4-STARS, or accumulate, ranking on the PFE shares.... The company lowered its earnings guidance for 2003 in early September, reflecting higher-than-expected expenses related to the acquisition of Pharmacia. However, we still believe its mainstay products remain strong in their marketplace, and so we believe investors should accumulate shares. There are no major pharmaceuticals that carry 5-STARS (buy) rankings. Only the generic drug manufacturer Mylan Labs (MYL ) carries a 5-STARS ranking.

Q: Outlook on Black & Decker (BDK )?


The BDK shares are ranked 5-STARS. The company earned $2.84 last year, and we see them earning $3.77 this year and $4.12 in 2004. We reiterated our buy recommendation on these shares on Oct. 1, after BDK completed the purchase of the Baldwin Hardware and Weiser Lock businesses from Masco (MAS ). We believe the deal will not materially affect '03 results but will be accretive in '04. The company is trading at a discount to the market, its peers, and its own historical average p-e.

Q: What's your outlook for telecommunications for 2004?


We currently are recommending that investors underweight their exposure to the telecom sector. Sales, earnings, and credit-rating trends are expected to continue to pressure these issues. We are a bit more optimistic, however, on the wireless category, but still have only two 5-STARS recommendations in this sector. They are Alltel (AT ) and Nextel Communications (NXTL ).

Q: Any recent additions to S&P's 5-STARS list? Also any recent sell or avoid recommendations?


On Monday, we added ImClone (IMCL ) to our 5-STARS list, due to the stock's recent price correction. On Oct. 9, we added Abercrombie & Fitch (ANF ), because we see an improvement in women's and girls' apparel trends. On Oct. 7, we upgraded Automatic Data Processing (ADP ) to a 5-STARS ranking, due to our outlook for an improving job market.

We have not added any stocks to our sell list in the last five days, but current names include Cablevision (CVC ), Great Atlantic & Pacific Tea Co. (GAP ), Northrop Grumman (NOC ), and SBC Communications (SBC ).

Q: What is your opinion on RF Micro Devices (RFMD )?


We have an accumulate, or 4-STARS, ranking on the RFMD shares. We see the company earning 2 cents per share in fiscal 2004 (March), jumping to 32 cents in fiscal '05. We upgraded these shares to accumulate from avoid on Sept. 8, as a result of an improved outlook for wireless-communications demand.

Q: What are your thoughts on Anheuser-Busch (BUD )? Do you think the Chinese market will be lucrative for them?


We're certainly optimistic on the share-price performance for the stock in the coming 12 months and therefore have a 5-STARS ranking on the BUD shares.... One of the reasons we do favor them is because of a growing market share, but I don't have any particulars on the Chinese market itself.

Q: What's your outlook for International Game Technology (IGT ) and the rest of the gaming sector?


We have a 3-STARS (hold) ranking on IGT shares. However, we're modestly positive on the overall gaming group. Our favorite in the category is Harrah's Entertainment (HET ). The IGT shares rose sharply on Oct. 13, after news that Harrah's had agreed to buy at least 11,000 new gaming machines. However, since the IGT shares are now trading at a 33% premium to the S&P 500, based on calendar '04 earnings estimates, we feel the IGT shares are fully valued.

Q: What STARS ranking does ATI Technologies (ATYT ) have?


We do not cover the ATYT shares analytically, but your question certainly indicates that a lot of interest is going into small-cap tech stocks. Technology has performed very well this year -- while the S&P 500 is up more than 18%, the tech sector has risen more than 40%, led by a triple-digit gain in Internet software and services companies, a more than 90% jump for computer storage and peripherals, and a near-80% advance for semiconductors. So first it was the large caps, and now it's on to the small caps.

Q: Do you like JetBlue Airways (JBLU )?


We currently have a hold ranking on the JBLU shares. We downgraded our ranking from accumulate to hold on Sept. 26, simply because of the sharp price gain. We continue to recommend holding JetBlue, considering the company's earnings-growth potential and strong relative strength, but we feel a bit put off by a p-e of 35 on 2004 earnings. There are no airlines that are ranked 5-STARS.

Q: How do you view valuations generally in the market now, Sam?


The S&P 500 was trading at 21 times trailing operating earnings, which is only a shade higher than the average trailing p-e of 20, dating back to 1988. If this p-e of 20 were applied to S&P analysts' earnings estimates for the S&P 500 for 2003 and 2004, we could see fair value at 1170 and 1200, respectively. In other words, while I earlier said that we don't think prices have come too far too fast, we also believe that valuations are not out of line, either.

Q: How about the financial-services sector? Any buy recommendations?


Yes -- in fact, there are 18 companies in the financial services sector that carry 5-STARS recommendations. One that surprised us nicely today with a nice earnings report is Bank of America (BAC ). Others include Capital One Financial (COF ), Commerce Bancorp (CBH ), and Vornado Realty Trust (VNO ). In general, we have 5-STARS recommendations in most industries within financials.

Q: Your thoughts on Exxon Mobil (XOM )? How about the rest of energy?


The XOM shares carry a 5-STARS ranking. Even though STARS is a price-appreciation-potential gauge, the company offers a nice dividend yield of 2.5%, vs. 1.7% for the S&P 500. Other energy stocks with 5-STARS rankings include Ensco International (ESV ), Evergreen Resources (EVG ), and Total (TOT ).

In general, however, we recommend a market weighting for the energy sector, as we see the price of oil edging down to about $28 per barrel on average at the end of this year, and then averaging about $24 for all of 2004.

Q: Despite a number of holds, it's good to see so many buys, Sam -- in this environment, any final advice for investors?


Yes, and that is that even though a slight pullback in the market, also referred to as a digestion of recent gains, is not out of the question in the coming months, we believe we're in the beginning of a new bull market, and modestly higher prices are expected this year and next year.

We recommend that investors focus on high-quality stocks in the economically sensitive areas of consumer discretionary and technology, along with selected issues in the health-care sector.

Edited by Jack Dierdorff

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