Rally Matches 1990s Gains With Valuations 28% LowerWhitney Kisling
Returns from the U.S. equity bull market that started four years ago are matching those from the last half of the 1990s even as valuations are 28 percent lower.
The Standard & Poor’s 500 Index has gained 26.2 percent annually including dividends since March 2009, the same as during the last 50 months of the technology bubble, according to data compiled by Bloomberg. Shares in the index now trade at 18.6 times annual profit, below the average 25.7 multiple in the 1990s rally led by Internet companies.
For bulls, the valuations show stocks will keep rising after the S&P 500 advanced 164 percent as individuals scarred by the worst financial meltdown since the Great Depression return to equities. Bears say the price-earnings ratios mean investors lack confidence in the economy and corporate profit growth. They also note that the last time returns were this high, the bubble popped and more than $5 trillion was erased from the value of U.S. stocks, according to data from the World Bank.
“The size of this rally’s not what keeps me up at night,” Paul Zemsky, the New York-based head of asset allocation for ING Investment Management, which oversees about $170 billion, said in a May 8 phone interview. “That was a tremendous rally then, too, but I’m not getting all nervous based on the size of the rally this time, because we’re not there yet in terms of valuation.”
U.S. shares rose last week, with the S&P 500 increasing 1.2 percent to 1,633.70, pushing its rally for 2013 to 15 percent. Regeneron Pharmaceuticals Inc., which has the index’s biggest gain since March 2009, advanced 2.8 percent, while hotelier Wyndham Worldwide Corp. climbed 3.4 percent to bring its return to 1,986 percent. The index rose less than 1 point to 1,633.77 today.
Price gains in this bull market have failed to push valuations above historical averages because unlike in the 1990s, they were accompanied by earnings growth that was almost as great. Profits at American companies have surged 20 percent a year since 2009, twice as fast as during the dot-com advance. Companies in the S&P 500 earned $784.5 billion in the last 12 months, compared with $431.3 billion in 2000 and $255.7 billion in 1996, data compiled by S&P show.
“Valuation and sentiment are much more reasonable,” Greg Woodard, a portfolio strategist at Manning & Napier in Fairport, New York, said in a May 9 phone interview. His firm had $48.1 billion at the end of the first quarter. “The mentality then was this was a new paradigm, it’s not like it was before, you don’t pay attention to the traditional fundamentals. Today, I would describe the conditions as more positive for investing.”
Concern the U.S. was at risk of another contraction prompted the Federal Reserve to take unprecedented action to spur growth during the last four years, pushing down interest rates and increasing the attraction of equities. The central bank pumped $2.3 trillion of stimulus into the economy and has held the benchmark lending rate near zero percent.
That’s different than what happened in 1999 and 2000, when the Fed raised its target rate for overnight loans between banks six times to 6.5 percent. Even with the policy, gains in gross domestic product have averaged 2 percent since 2009, less than half the rate as the 50 months through March 2000.
While the advance since 2009 that added $11.3 trillion to the value of stocks is comparable to the last four years of the technology bubble, it remains weaker than returns generated in that rally’s strongest stretch. The S&P 500’s level almost tripled during the 50 months starting in December 1994. Reaching gains of a similar size would have required the index to climb to about 1,918, or 17 percent above last week’s close.
One version of the S&P 500 is posting returns that big. The so-called equal weighted index that strips out biases related to company value has surged 208 percent, or 31 percent annually, since March 2009, data compiled by Bloomberg show. It rose about half as much as the weighted S&P 500 during the 1996 to 2000 period.
Breadth has characterized the advance since 2009. About 89 percent of stocks in the benchmark index are trading above their average price from the past 50 days, compared with 65 percent on March 24, 2000, when the Internet bubble burst, data compiled by Bloomberg show. Only 27 stocks made a new 52-week high at the peak of the market in 2000, compared with 74 last week.
“The bull market in 1999 and into early 2000 was increasingly narrow in terms of the number of companies driving the performance of the market,” Mark Luschini, chief investment strategist at Janney Montgomery Scott LLC in Philadelphia, which manages $55 billion, said in a May 8 phone interview. “You have not yet seen the level of euphoria you saw in 1999, when it was driving equity prices north of 30 times earnings,” he said. “That level of skepticism is encouraging from a contrarian standpoint.”
While valuations are 28 percent below the 1990s rally, low earnings multiples are also a sign that investors don’t trust the economy will grow fast enough to support analyst estimates of future profits. S&P 500 earnings rose 1.8 percent in the quarter ending March 31, more than 11,000 analyst estimates show. That compares with an average of 4.7 percent last year and 25 percent in 2010 and 2011, according to Bloomberg data.
“Even though the market’s up, there’s still a great deal of concern from investors,” Matt McCormick, who helps oversee $9.1 billion as a money manager at Cincinnati-based Bahl & Gaynor Inc., said in a May 9 phone interview. “It’s a situation where people really need to be selective.”
The breadth of this rally is also a consequence of investors favoring industries where earnings are less likely to plummet should the economy weaken. Health-care and household product companies posted the biggest gains in the S&P 500 last quarter, at 15 percent and 14 percent. So-called defensive shares have an average dividend yield of 2.4 percent, compared with 1.7 percent for cyclical stocks, data compiled by Bloomberg show.
Advances in companies that fund managers buy when they are expecting gains to slow have resulted in a smaller spread between the market’s leaders and laggards compared with the dot-com era. During the 1990s, computer makers and software designers surged 587 percent, more than four times as much as any other industry in the S&P 500 and at least 31 times more than utilities and household-product makers. Since March 2009, consumer discretionary shares have jumped 258 percent, or about three times as much as the worst-performing industries.
Yahoo! Inc., the search engine operator, posted the biggest gain in the last 50 months of the 1990s rally, surging 180-fold, while personal-computer maker Dell Inc. rose about 7,000 percent. The biggest gains since March 2009 are Regeneron in Tarrytown, New York, at 2,106 percent, Parsippany, New Jersey-based Wyndham at 1,986 percent, and television network CBS Corp., up 1,445 percent.
Eighteen stocks increased by more than 1,000 percent during the last 50 months of the 1990s rally, twice as many as now. With fewer companies posting returns of that size, individual investors have yet to return to stocks, according to Nick Sargen, who oversees almost $45 billion as chief investment officer at Fort Washington Investment Advisors in Cincinnati.
“The retail investors are more momentum-based, so they don’t go buy names because they’re cheap, they say look, that stock’s on a tear, I want some of that,” Sargen said in a May 8 phone interview. “That’s what was happening in the 1990s. It was a momentum driven market, and the thing was it was a good call for five years, so you did OK, until you didn’t,” he said.
“This just hasn’t been a momentum-driven market today,” Sargen said. “Retail investors have just missed the rally and they’re only now starting to become converts.”
Mutual funds owning bonds have received more than four times as much money as those owning U.S. stocks in 2013, data from Washington-based Investment Company Institute show. Investors withdrew almost $400 billion from American equity funds over the last four years and added more than $1 trillion to bonds.
Treasuries have underperformed stocks during the bull market, losing 0.1 percent this year, compared with the S&P 500’s 15 percent, data from Bank of America Merrill Lynch and Bloomberg show. While bonds beat stocks in 2011, equities outperformed in 2010 and 2012, giving stock investors a total return about nine times as big as bondholders since March 2009.
In its broadest definition, the 1990s technology rally represented the conclusion of a bull market that began a decade earlier, in 1987, which produced a total return in the S&P 500 of 843 percent and annual gains of 20 percent, data compiled by Bloomberg show. While the rally since 2009 has lasted only about 30 percent as long, it’s approaching the average of five years for advances that lasted more than four months since World War II.
“That momentum just went on and on and on in ’96, ’97, ’98 and ’99, and it just got completely out of hand,” Brian Barish, president of Denver-based Cambiar Investors LLC, which manages about $8 billion, said in a May 9 phone interview. “We’re still finding lots of stocks today that are very compressed for what they are,” he said. “There’s a pretty good story out there this time.”