Losses Erased for S&P 500 as Fed, Economy Spur Recovery

U.S. equities recouped $1 trillion of share value that was erased in the last seven weeks, as Federal Reserve Chairman Ben S. Bernanke pledged to preserve stimulus and stocks rallied on signs of economic expansion.

Yesterday’s 1.4 percent gain wiped out losses for the Standard & Poor’s 500 Index that had swelled to as much as 5.8 percent in the month after Bernanke raised the prospect of slowing bond purchases. Stocks rose in 10 of the last 12 days. Target Corp., Boeing Co. and 131 other companies are trading at 52-week highs, almost three times the average at four S&P 500 peaks between 1990 and 2007, data compiled by Bloomberg show.

Investors who had been putting aside concern U.S. policy makers will reduce stimulus kept buying this week after Bernanke said “highly accommodative monetary policy for the foreseeable future is what’s needed.” While bears say the rally won’t survive earnings reports that analysts estimate will be among the weakest in four years, bulls say an expanding economy ensures that future profits will rise and lift stocks.

“The realization is sinking in that the only way there is going to be a Fed tapering by the middle of next year is if there is consistent economic improvement,” Michael James, a Los Angeles-based managing director of equity trading at Wedbush Securities Inc., said in a July 8 phone interview. “If there isn’t, the Fed support is going to remain there. If there is a strengthening in the economy, the Fed will pull back. That is a net-positive for stocks, not a net-negative.”

Improving Data

The S&P 500 advanced 1 percent on June 25 after durable-goods orders and home sales rose more than forecast and consumer confidence increased. That gain extended to the biggest three-day rally since January as unemployment claims declined and consumer spending rebounded. The index rose 1 percent after a July 5 report showed the U.S. added 195,000 jobs in June, more than the median forecast in a survey of 83 economists. The equity benchmark gained 0.3 percent to 1,680.19 at 4 p.m. in New York today.

“It’s a little weird at this juncture to see that good news is good news,” Mark Luschini, chief investment strategist at Janney Montgomery Scott LLC in Philadelphia, which manages $58 billion, said in a July 8 phone interview. “If you take the Fed at face value, meaning the economy is expected to accelerate, and then you see data points that largely vindicate that, why should markets be spooked?”

‘Step Down’

Stocks tumbled 0.8 percent on May 22, when Bernanke said the Fed could “step down” the pace of its $85 billion monthly bond purchases in the next few meetings if the labor market continues to improve. They plunged 3.9 percent in the biggest two-day loss since November 2011 after the Federal Open Market Committee said June 19 that risks to the outlook for the economy and the labor market have diminished.

Gains in equities have come as bond yields jumped. While the rate on the benchmark 10-year Treasury note retreated for the last four days, it had climbed to 2.75 percent this week, the highest level since August 2011, Bloomberg data show.

Investors pulled money from stock and bond mutual funds as rates rose. Fixed-income managers lost $66.6 billion the last five weeks to withdrawals, while funds that invest in U.S. equities saw about $8.4 billion in outflows, according to the Investment Company Institute. Investors have pulled almost $400 billion from share funds and deposited more than $1 trillion with bonds since 2009.

Healing Economy

“During the last four years, as the world worried and capital sought refuge in government bonds, high-yield bonds, real estate, timber, gold, art and any number of exotic and plain vanilla hedge funds, the economy went about healing,” Howard Ward, the chief investment officer at Rye, New York-based Gamco Investors Inc., which oversees $36.7 billion, said July 9. “You have to be in stocks.”

Gains this month have coincided with comments from Fed officials that bond purchases will continue, suggesting that expectations for more stimulus are the main reason for the advance, according to Eric Zoldan, a New York-based certified investment management analyst with JHS Capital Advisors LLC, which oversees $3.5 billion. While unemployment has come down from a 26-year high of 10 percent, the labor market hasn’t improved enough to support economic growth, he said. Unemployment was unchanged at 7.6 percent in June, the Labor Department said July 5.

The three-day surge at the end of June came as Fed Bank of Richmond President Jeffrey Lacker forecast that the U.S. expansion will remain sluggish for “a couple more years” and Fed Bank of New York President William C. Dudley said the central bank may prolong its asset-purchase program. Gross domestic product expanded at 1.8 percent in the first quarter, trailing economist projections and adding to speculation the Fed would maintain the pace of quantitative easing.

Bond Market

“The fundamentals are not getting better, they are getting worse,” Zoldan said in a July 9 telephone interview. His firm oversees $3.5 billion. “I do not believe that that money is going to come out of the bond market with big losses and turn into the equity market.”

S&P 500 earnings rose 1.8 percent last quarter, the second-lowest period since 2009, according to more than 11,000 analyst estimates compiled by Bloomberg. Gains in profits have been slowing since the beginning of 2012, with quarterly growth averaging 4.3 percent, compared with 28 percent in the previous two years, according to data compiled by Bloomberg.

The S&P 500 fell as much as 5.8 percent between May and June, breaking the 149-day streak of days without a 5 percent decline. The stretch was the longest since February 2007, about eight months before the end of that bull market, according to data compiled by Bloomberg.

Equity Corrections

There have been 57 instances since 1946 where the S&P 500 posted losses of between 5 percent and 10 percent from a peak, according to a study by Sam Stovall, S&P’s chief equity strategist. On average, the retreats lasted a month, and it took two months for the market to recover the losses, the data show. Among them, only a third eventually turned into corrections, or declines of more than 10 percent.

The 148 percent rally since the 12-year low in March 2009 hasn’t pushed the index’s price-earnings ratio above the 25-year average of 18.6, according to data compiled by Bloomberg and S&P. Valuations have held steady as profit growth matched gains in share prices, leaving the S&P 500 to trade at 16.2 times reported earnings this week.

Analysts are projecting this year’s rally will continue even as earnings weaken, giving stocks higher multiples. The U.S. equity gauge will increase 6.3 percent to a record 1,781.28 should their price forecasts prove accurate.

Index Highs

While the S&P 500 surpassed its record close yesterday, the Russell 2000 Index of smaller companies set a new high on July 5, climbing 1.4 percent to 1,005.39. It’s gained another 2.8 percent since then. The Dow Jones Industrial Average’s 1.1 percent advance yesterday pushed it to a record 15,460.92.

“Confidence is running through the markets,” James Paulsen, the Minneapolis-based chief investment strategist at Wells Capital Management, which oversees more than $340 billion, said July 9. “I would overweight stocks over bonds today not only because I think they will outpace during the balance of this year, but also because the stock market is likely to make another nice move higher in 2014 even if bond yields rise again next year.”

Before it's here, it's on the Bloomberg Terminal.