A Bull Market May Be Hiding in Your Portfolio

Times Staff Writer

The stealth bull market is back.

After a nerve-wracking mid-May to mid-June slump, the stock market spent most of the summer slowly working its way higher -- slowly enough that the rebound may have gone largely unnoticed by many investors.

Yet the blue-chip Standard & Poor’s 500 index now is up 5.7% year to date, and is less than 1% away from its five-year high set on May 5.

More impressive, the Dow Jones industrial average, which jumped 168 points last week to end Friday at 11,560.77, is within 1.5% of its all-time high reached in January 2000.


Check your own portfolio: You’ll probably find that you’re doing better this year than you thought.

A lot of things that could have gone wrong this summer didn’t. The U.S. economy continued to slow, but it didn’t fall off a cliff; the feared global bird flu pandemic failed to materialize; and the Atlantic hurricane season has been mild so far.

Meantime, consider what went right: The Federal Reserve finally paused in its two-year-long credit-tightening campaign; long-term bond yields fell sharply; blue-chip corporate earnings continued their streak of double-digit quarterly growth; and oil and natural gas prices plunged.

Not surprisingly, stock market optimists believe they have the upper hand as the fourth quarter looms.

“I think you have to work hard to find parts of the equity market that you don’t want to hold here,” said Ernie Ankrim, chief investment strategist at Russell Investment Group in Tacoma, Wash.

He says the S&P; 500 index could reach 1,425 by year’s end, which would be a gain of about 8% from its current level.


Key to the bullish outlook is faith that the U.S. economy is experiencing a soft landing after three years of strong growth. What’s implied by code words such as soft landing and “mid-cycle slowdown” is that the deceleration eventually will give way to faster growth, rather than to a recession and a collapse of corporate earnings.

Fed policymakers boosted hopes for a soft landing when they opted at their Aug. 8 meeting to hold their benchmark short-term interest rate at 5.25%, after 17 consecutive hikes.

They are expected to stay on hold when they gather Wednesday. That decision will be easier in part because falling oil prices are reducing the risk of inflation. And many Wall Street pros believe that the next change in the Fed’s rate will be a cut, perhaps as early as the first quarter of next year.

That partly explains why many stocks have recouped much or all of their spring losses, said Rick Campagna, a fund manager at Provident Investment Counsel in Pasadena.

“I think the market is starting to anticipate rate cuts,” he said.

The bond market certainly is betting on a drop in short-term rates: The 10-year Treasury note yield, a benchmark for mortgages and other long-term interest rates, has fallen to 4.79% from a four-year high of 5.24% in June.

More telling, perhaps, is that the three-month T-bill yield, which normally hews very close to the Fed’s rate, has been drifting lower for the last three weeks, to the current 4.94%.


So no matter where you look among Treasury securities -- from three months to 30 years -- yields are below the Fed’s rate of 5.25%. When longer-term interest rates are below short-term rates, that’s what is known as a yield inversion. It means rates are upside down.

The bad news of a yield inversion, historically, is that it often has signaled a recession rather than merely a slowdown.

Paul Kasriel, an economist at Northern Trust Co. in Chicago, is in the soft-landing camp. But he says, “The risks are to the downside,” which is what bonds seem to be telegraphing.

“Housing is in a recession and consumers are starting to slow their spending,” Kasriel said. In an environment like this, he said, economic accidents can happen.

In a forecast last week, the watchdog International Monetary Fund estimated U.S. real gross domestic product growth would be 3.4% this year and dip to 2.9% next year.

But the IMF also warned that “a sharp adjustment in the housing sector would generate strong headwinds for the U.S. economy,” jeopardizing overall growth.


If the stock market were seriously confronting the possibility of a recession -- and falling corporate earnings -- it’s highly unlikely share prices would be where they are now.

Look what Wall Street has done to home builders’ shares as many of those companies have reported declining earnings this year: An S&P; index of 16 major builder stocks has plummeted 35% over the last 12 months.

The builders have gotten the worst of it, but shifts in the broad market over the summer show that many investors have been repositioning their portfolios for weaker economic growth.

Shares of many industrial and commodity-related companies either have been slow to rebound from the spring sell-off or have continued to fall.

Likewise, small-company stocks, on average, remain well below their all-time highs reached in spring. The S&P; 600 small-stock index is 8% below its record high set on May 8, although it’s up 6.6% for the year.

Nervous investors’ preference in recent months has been for big-name companies (less chance of financial calamity in a recession, people figure) and for those firms whose sales are less dependent on the economy’s strength. Cases in point: Shares of drug giant Pfizer Inc. and McDonald’s Corp. both hit 52-week highs last week.


Also last week, however, some buyers snapped up shares of truckers, airlines and other companies that are more sensitive to the economy’s swings. It helped that oil prices fell to their lowest level in nearly six months.

The market as a whole has been strong enough since mid-June to lift the average U.S. stock mutual fund into the black, from close to breakeven. The average fund now is up 4.8% this year, according to Morningstar Inc.

That still pales compared with the average foreign stock fund, which is up 10.8%.

But if the economic soft landing is for real, there should be more to come for laggard domestic stocks, said Larry Adam, investment strategist at Deutsche Bank Alex. Brown in Baltimore.

U.S. equities, he said, could gain, particularly if investors continue to see less potential in commodities and residential real estate, which have attracted mountains of money since 2002.

As capital looks for somewhere better to go, “I think you have a pretty solid outlook for stocks,” Adam said.





Measures of the market

Financial-service stocks have been strong performers this year, amid hopes for an end to interest rate hikes. By contrast, energy stocks, though up this year, have recently faded with falling oil prices.

Gains in key market indexes year to date

NYSE financial: +10.1%

NYSE composite: +7.9%

Dow industrials: +7.9%

S&P; small-cap: +6.6%

S&P; 500: +5.7%

NYSE energy: +4.5%

S&P; mid-cap: +1.8%

Nasdaq composite: +1.4%


Returns do not include dividends


Source: Bloomberg News