For Year Three of Stock Rally, a Healthier Tone?
The first bull market of the 21st century turns two years old this week.
That sounds a lot more dramatic than how it must feel to many investors.
Last year, stocks were red-hot. This year has been much more of a struggle, at least since most key market indexes topped out in January or February.
But measured from its first birthday, on Oct. 9 of last year, this bull’s performance isn’t so bad -- especially considering the alternatives.
Through Friday, the blue-chip Standard & Poor’s 500 index was up 8.9% from Oct. 9, not including dividends.
That was well below the 33.7% price surge that the S&P; recorded in the first 12 months after the bear market ended on Oct. 9, 2002. Still, bull markets always post huge gains at the outset, then cool down.
In the first year of the mega-bull market that began on Aug. 13, 1982, the S&P; soared 58.3%. In the second year the index added just 2%. That wasn’t the end of it, as anyone who was lucky enough to be on board in the 1980s can attest.
There still are some investors who question whether this is a genuine bull. Some say it’s just a bounce within a longer-term bear market. In any case, if you’ve sat it out you’ve left a lot of money on the table.
What about year three? If the bull celebrates a third birthday in 12 months, most Wall Street pros say it won’t have been an easy journey.
That’s what you would expect them to say, of course; this is a market in which the fear level is high, and for good reasons.
The Federal Reserve is tightening credit; corporate earnings growth is slowing; oil is above $50 a barrel; stock prices aren’t cheap by historical yardsticks; the situation in Iraq is frightening; and the threat of a terrorist attack on U.S. soil looms over every other worry.
For all that, the stock market put on a good show on Friday, the first day of the fourth quarter. The Dow Jones industrials jumped 112.38 points, or 1.1%, to 10,192.65.
The technology-dominated Nasdaq composite, the notable laggard in this second year of the bull market, surged 45.36 points, or 2.4%, to 1,942.20. That put it back in the black as year two draws to a close: It’s up 1.6% since Oct. 9.
Some analysts have pointed to the generally poor performance of the tech sector this year as a sign that investors learned their lesson in the last bear market about paying too much for stocks relative to underlying earnings.
After the rebound in tech stocks in 2003, they hit a wall in January. At that point, shares of computer networking giant Cisco Systems Inc. were priced at 40 times estimated 2004 earnings per share. Investors began to balk; the stock now is down 36% from its January peak.
While big-name tech issues have slumped this year, investors have snapped up stocks that have traditionally been viewed as conservative choices -- for example, electric utilities, real estate investment trusts and major energy companies, most of which pay fat cash dividends.
Some of those sectors were helped by Congress’ decision in 2003 to slash the federal income tax rate on dividend income. (Real estate investment trust dividends mostly don’t qualify for the tax cut, however.)
Many old-line industrial stocks also have roared back into favor this year. Investors are betting on a continued pick-up in business capital spending and rising demand from fast-growing economies in Asia. For much of this year, industrial stocks also had the advantage of selling for price-to-earnings ratios that seemed reasonable, if not cheap.
The more conservative feel to the bull market in year two encourages Chris Wolfe, head of equities at J.P. Morgan Private Bank in New York.
He said he worried that corporate earnings growth could be weaker next year than most investors are expecting. Yet Wolfe doesn’t see significant risk of a plunge in share prices, he said, in part because investors have been favoring higher-quality stocks, in his view.
What’s more, many people no longer assume they’ll see giant gains in stocks in the next few years, Wolfe said. “Expectations of future returns have come down,” he said. He thinks that’s healthy.
Investors’ willingness to buy long-term bonds at current yields also suggests a guarded mindset: If 4.19% turns out to be a good annualized return on a 10-year Treasury note, the bar is lowered for stocks as well.
All of this raises hope that a more conservative tone could extend the bull market’s life.
But some data from year two would seem to question the idea that Americans are approaching stocks with a cautious attitude.
Shares of smaller firms have risen much more sharply than blue chips this year. A Standard & Poor’s index of 600 smaller stocks hit a record high Friday, and is up 18.2% since Oct. 9.
It isn’t as if smaller stocks have just come back into favor; they have far outpaced blue chips since 2000. That is raising flags for some market pros, who worry that investors are overpaying for what can be very risky shares.
Likewise, emerging markets overseas have attracted enough money to make them the best-performing of major mutual fund sectors over the last two years, according to Lipper Inc. This, too, is a high-risk stock sector.
And within technology, some Internet stocks this year have scored price gains that are reminding some investors of the last gasp of the dot-com bubble.
There always are exceptions to broad market trends. But in the case of smaller stocks and emerging markets, maybe they don’t contradict the idea that investors generally are more conservative. Maybe those sectors are benefiting as more investors follow the best advice of all in building a portfolio: spread your money around many different types of assets.
Investors have many reasons to be concerned about the stock market’s future, but simply staying away doesn’t make sense, said Charles Carlson, who manages money at Horizon Investment Services in Hammond, Ind.
“The way you handle the risks is to have a diversified portfolio,” he said.
Timeless advice.
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Tom Petruno can be reached at tom.petruno@latimes.com.
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BullÕs progress The bull market turns 2 years old on Oct. 9. Key indexesÕ gains in year one and so far in year two: Pctg. change Index Year 1 Year 2 S&P; small-cap +47.4% +18.2% Russell 2,000 +59.4 +12.2 S&P; mid-cap +44.1 +12.0 S&P; 500 +33.7 +8.9 Dow 30 +32.9 +5.3 Nasdaq +71.6 +1.6
Source: Times research ** How sector gains stack up Two years into the global bull market, emerging-markets stock funds have posted the biggest gains, while U.S. large-cap growth funds have generated the weakest returns among major stock fund categories.
Average annualized total returns by fund sector, two years ended Thursday
Emerging markets: +33.8% Natural resources: +32.7% Technology: +27.8% Small-cap value: +26.7% European region: +25.8% Real estate: +25.6% Mid-cap value: +25.5% Small-cap growth: +20.8% Large-cap value: +19.4% Mid-cap growth: +18.6% S&P; 500 index: +18.3% Large-cap growth: +13.7%
Source: Lipper Inc.
