Bull Market Confirmed Through 2013 by 23 Years of RalliesWhitney Kisling and Alex Barinka
The broadest rally in U.S. stocks since at least 1990 has lifted shares of everything from the smallest companies to the biggest banks, signaling the bull market for America’s largest corporations will last at least until the end of the year, if history is a guide.
The Standard & Poor’s 500 Index’s advance to a record last week coincided with highs in the Russell 2000 Index of smaller companies, the Dow Jones Transportation Index, the S&P 500 Financials Index and a gauge of economically sensitive equities overseen by Morgan Stanley. Since 1990, the S&P 500 has gained for six months on average after those measures peaked, according to data compiled by Bloomberg.
While bears say the breadth shows indiscriminate buying just as profit growth slows and the Federal Reserve prepares to curtail stimulus, gains across stock measures have proved an accurate forecaster of performance. In four market tops during the last 23 years, small-cap stocks and the cyclical gauge never peaked after the S&P 500.
“It is pretty broad slice of America you are looking at,” John Manley, who helps oversee $222.7 billion as chief equity strategist for Wells Fargo Funds Management in New York, said in a July 17 phone interview. “What that is saying is that you have an economy that is improving somewhat, but the market has not been hyper-extended and the Fed is still accommodative. What’s not to like about that?”
U.S. stocks rose for a fourth week, pushing the S&P 500 up 0.7 percent to 1,692.09 and bringing this year’s gains to 19 percent, after Fed Chairman Ben S. Bernanke said there was no fixed schedule for ending the program of bond purchases known as quantitative easing. Delta Air Lines Inc. and Morgan Stanley led transport and financial shares, climbing at least 5 percent. The S&P 500 gained 0.2 percent to 1,695.53 at 4 p.m. New York time today.
More than $1 trillion has been restored to share values as markets recovered after Bernanke’s warning that stimulus may slow sent the S&P 500 down as much as 5.8 percent between May 21 and June 24. The index is up 150 percent since March 2009 amid a doubling of corporate earnings.
Gains in small-caps, banks, transportation companies and cyclical stocks suggest the rally isn’t over, according to Doug Ramsey, the Minneapolis-based chief investment officer of Leuthold Group LLC, whose firm oversees $1.7 billion and recommended buying equities in March 2009.
During the four biggest bull markets of the last quarter century, peaks in those indexes have come before the S&P 500 reached its highest level almost 90 percent of the time, data compiled by Bloomberg show. The benchmark gauge has rallied another 7 percent after they began declines, on average.
“We just have to respect the uniformity of the market’s action,” Ramsey said in a July 16 phone interview. “Until it gets more disjointed, the odds are for even higher highs.”
The S&P 500’s rally from January to June was the best first half since 1998. A total of 460 stocks in the index are up this year, the most since at least 1990, and more than 90 percent traded above their 200-day rolling averages last week, data compiled by Bloomberg show. That compares with 62 percent over the past 23 years.
That’s a reason for caution, said Leo Grohowski, chief investment officer of New York-based BNY Mellon Wealth Management, which oversees $188 billion. Increases in stock market breadth will work against bulls should earnings growth slow and investors become convinced all at once that Bernanke will curtail stimulus as the economy improves.
“I would be careful about assuming the past as a reliable indicator for the future mainly because the interest rate support for the market is not going to be as strong,” he said in a July 17 telephone interview. “Actual news of economic improvement will increase concern about the Fed removing the punchbowl of liquidity.”
Reports showing U.S. economic growth is picking up while it slows elsewhere have given American equities the third-best returns in the developed world this year, behind Japan and Ireland. American employers added an average of 196,000 jobs in each of the last three months, topping economists’ forecasts. At the same time, China’s gross domestic product grew 7.5 percent in the second quarter from a year earlier and is at risk of the weakest expansion in 23 years.
Profits for the S&P 500 probably rose 2.4 percent in the second quarter from a year ago, according to more than 11,000 analyst estimates compiled by Bloomberg. That compares with an average of 4.3 percent in the last five earnings periods and 28 percent in 2010 and 2011. About 73 percent of companies have exceeded forecasts this month, matching last quarter.
Average U.S. price-earnings ratios have expanded by 15 percent this year. At 16.3, the S&P 500 multiple is near the highest since the middle of 2010 and compares to 17.5 when the last bull market ended in October 2007.
The simultaneous rallies are “coincidence” and valuations suggest past patterns are unlikely to be repeated, Uri Landesman, president of New York-based hedge fund Platinum Partners, who helps manage about $1.2 billion, said by phone July 18. “The market is priced for perfection and there is hardly perfection in the world,” he said.
The Russell 2000 Index of companies with an average market value of $901 million set records this month, extending its gain from March 2009 to 206 percent, according to data compiled by Bloomberg. Banks in the S&P 500 have risen 27 percent this year to the highest levels since 2008. The Morgan Stanley Cyclical Index of 30 companies, including Whirlpool Corp. and Hewlett-Packard Co., reached a record on July 19.
All three indexes and transports peaked within 35 days of each other in 1989. The S&P 500 went on to gain about 7 percent in the next 10 months. In July 2007, the four groups were already beginning to slump and the S&P 500 rallied the next three months to hit an all-time high 1,565.15 on Oct. 9.
In 1999, the benchmark gauge advanced about 15 percent in the 11 months after cyclicals, banks and the measure of shipping companies reached a high.
Increases by the measures have foretold economic expansion in the past. Small-caps surged 39 percent from April to October 1997 and went on to set a record in April 1998. U.S. GDP grew 4.5 percent in 1997, the fastest since 1984, and climbed 4.8 percent by 1999, data compiled by Bloomberg show.
“It is very typical, almost prototypical, of a classic early-stage recovery,” Rich Weiss, the Mountain View, California-based senior money manager for American Century Investment who helps oversee $130 billion, said in a July 17 phone interview. “It is what I learned at Wharton 30-something years ago, and it still holds true today. Those are the classic early-cycle sectors and indicators.”
Earnings for financial firms, the second-biggest group in the S&P 500 after technology shares, increased 26 percent last quarter, more than any other industry, analyst estimates show. Profits are expected to climb 14 percent for cyclicals in 2014, about 3 percentage points more than the full market.
The median stock in the Russell 2000 is up 8 percent in the last 30 days, according to data compiled by Bloomberg. Alliance Fiber Optic Products Inc., the maker of communications parts, gained 141 percent this year. After beating earnings estimates for four consecutive quarters, the Sunnyvale, California-based company will report that profits more than doubled last quarter, according to research firm B. Riley & Co.
Transportation stocks, projected to boost profits more than three times as much as the S&P 500 in 2013, climbed 24 percent so far this year and reached a record July 19. Delta, the second-largest carrier by passenger traffic, rose 71 percent as the Atlanta-based company beat profit estimates. Delta should increase earnings 46 percent for the full year, according to analyst forecasts.
Union Pacific Corp., the largest U.S. railroad, rose 30 percent this year, 11 percentage points more than the S&P 500. The Omaha, Nebraska-based company has posted 14 consecutive quarters of earnings growth. Annual per-share earnings should rise 15 percent a year in 2013 and 2014, estimates show.
“All of these things tie in together,” Phil Orlando, New York-based chief equity strategist at Federated Investors who helps manage $380 billion, said in a July 17 phone interview. “Because the market is a forward-looking discounting mechanism looking out a couple to three quarters, this tells us that this economic and stock-market rally would improve.”