Leaders Are Missing for Long-Term Rally

By JOSH FRIEDMAN

Sept. 9, 2002 12 AM PT

TIMES STAFF WRITER

Where are the market’s leaders?

That’s what many investment strategists are asking as they try to determine whether stocks finally hit bottom in midsummer.

The blue-chip Standard & Poor’s 500 index, which rallied 20.7% from its five-year low July 23 to Aug. 22, has lost 7.1% since then, raising the threat of another leg downward for the 29-month-long bear market.

Stocks rallied Friday, but major indexes still lost ground for the week. Within the S&P; 500, 78 stock industry groups fell for the week, while 26 rose.

“In the middle of August everybody was screaming, ‘We’ve finally seen the bottom, now we’re going to the moon!’ ” said John Bollinger, head of Bollinger Capital Management in Manhattan Beach. “How are we going to the moon if there are no dogs pulling the sled?”

A new bull market needs strong leadership in the form of gains across many industry sectors, analysts say. But in the last four weeks, 62 S&P; 500 industry groups have fallen, while 41 have risen.

What’s more, investors have shown a renewed aversion to risk in recent weeks, favoring the kind of “defensive” stocks not usually associated with a robust bull move, said Kevin Marder, a Los Angeles-based strategist at Ladenburg Thalmann Asset Management.

Leading groups over the last four weeks have included such typically defensive sectors as home improvement retailers, gold miners and brewers. Also, snapbacks in such deeply depressed groups as movie companies (mainly AOL Time Warner Inc.), airlines and wireless services have made them top performers for the moment.

Meanwhile, the technology and industrial issues that often have led at the start of bull markets have been among the worst performers over the last month.

“It’s symptomatic of the whole problem: The speculative sentiment that you need to see early in a new bull market simply is not there,” Marder said. Defensive stocks can be leaders, as they were in 1988 and 1989, but generally “not in the healthiest, most durable bull markets,” he said.

What’s more, worries about the market’s staying power are prompting some investors to take paper gains quickly, strategists say. That is making it difficult for leading sectors to stay leaders and build momentum and interest.

The home-building sector, for example, a pillar of strength earlier in the year, has weakened lately. S&P;’s home-building stock index is off about 14% from its all-time peak in late June. More weakness in the sector could be a sign that the market is anticipating a return to recession, Marder said.

After the broad market hit its trough July 23, health care and financial services stocks showed strength initially, said Ron Rowland, editor of All Star Fund Trader, an Austin, Texas-based newsletter. Health care stocks have faltered recently, however, and financial shares have turned mixed, with banks and savings and loans strong while brokerages slump.

Meanwhile, few individual stocks are breaking out to substantial new highs, Marder said. H&R; Block Inc., for example, edged past its 52-week closing high Aug. 19, then topped out at $53.15 the next day. The stock had pulled back to $50.91 as of Friday.

“If institutional investors had more conviction, you would expect to see a stock like that run for another 15% to 20%,” Marder said.

Bollinger called the market’s lack of clear leadership “the best argument for why we probably haven’t hit the bottom.”

Regardless of whether the midsummer lows hold, many analysts say that when the next bull market begins in earnest, investors should not expect the former leaders--namely technology and telecom--to set the pace again.

In the 1990s, semiconductor stocks were considered market leaders, Rowland said.

“They’re still ‘leaders’--but to the downside now,” he said, noting that the so-called SOX index of 17 major semiconductor stocks has set a string of new lows since July 23, including one Thursday.

The tech-heavy Nasdaq composite, which rallied 18% from its low Aug. 5 through Aug. 22, has slumped 9% since then.

Historically, it’s rare for the biggest winners of one bull market to be the leaders of the next. In many cases, fallen stocks never return to their old highs--or take a painfully long time to do so.

Coca-Cola Co. did not overtake its 1973 peak until more than 12 years later, Marder said. “And that was a company with earnings,” he added, in a jab at the tech sector.

Bollinger said that in addition to the fundamental problems tech and telecom firms face because of the reluctance by corporate managers to step up capital spending, many of the stocks are still overvalued even at lower prices.

Sun Microsystems Inc., for example, trades at a price-to-earnings multiple of 88 based on analysts’ consensus fiscal 2003 profit estimate of 4 cents a share and Friday’s closing stock price of $3.54. The S&P; 500, by comparison, carries a P/E of about 15 based on 2003 earnings estimates.

If history is a guide, sectors that lagged during the bull market from 1998 to 2000 but have held up well during the bear market of the last 2 1/2 years may be among the leaders of the next bull market, said Richard McCabe, chief market analyst at Merrill Lynch in New York.

Sectors that fit that mold include basic industry, including chemical and paper producers; capital goods, including machinery stocks; energy, including oil and gas explorer/producers; and consumer cyclicals, including auto parts makers.

McCabe said tech may not be able to sustain market leadership again for the foreseeable future, but the stocks could see a burst of strength late this year or in 2003, perhaps lasting six months or so, as hopes for a return to the heady days are revived--albeit just for a while, he said.

That’s what happened with the “Nifty Fifty” U.S. blue-chip stocks in 1975 and with Japanese stocks in 1993, McCabe said.

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Leading Stock Sectors in the Last Four Weeks

Here are the best-performing stock industry sectors in the Standard & Poor’s 500 index in the four weeks ended Friday.

Four-week average gain by sector:

Broadcast/cable TV 24.90%

Home improvement retailers 18.8

Movies/entertainment 13.3

Apparel retailers 9.4

Office electronics 8.5

Advertising 8.5

Gold mining 6.7