Each week, we tap the insight of Sam Stovall, Chief Equity Strategist for S&P Capital IQ, for his perspective on the current market.
EQ: This week marks the three-year anniversary of when the S&P 500 bottomed from the recession. How has the market performed since bouncing off the low on March 9, 2009?
Stovall: If you can believe it, the S&P 500 closed at 676 on March 9, 2009. So just from the potential profit one could have made by biting the bullet and diving into stocks when things looked the bleakest, you’re probably thinking, “Oh my gosh, what I wouldn’t give today to have known what was going to happen three years later and get back into the market back then!” The S&P 500 is currently trading around 1370, so we’re over 100 percent higher than where we were back then.
EQ: In your latest Sector Watch report, you discussed the disagreement between those that believe the market is still in that initial bull market from 2009, versus those that think the market has entered a new bull market since the low of October 2011. What are the implications for investors of the market being in one versus the other?
Stovall: The primary difference is the magnitude of the potential advance. In the first year of a bull market, people are typically surprised by the strength of the bull market. On average, going back to World War II, the S&P 500 gained an average of 38 percent in the first year of a bull market. We had gains from as little as 21 percent–which is still a nice advance from the prior low–and we also had advances of 58 percent in 1982-83. In the first year of this bull market from March 9, 2009 to March 9, 2010, we were up close to 70 percent. So it was a very strong advance in the first year.
The reason why it’s important to at least get an understanding as to whether we’re in the first year or the fourth year of a bull market is because in the fourth year of a bull market, the average price increase is 12.5 percent. That is basically one-third of what we received in year one. So the difference between year one and year four is the potential gain that we still have ahead of us. If you thought we were in your four you might give up on this bull market sooner than you should.
So we could be entering year four of the initial bull market on March 10, because we officially did not close into a new bear market on Oct. 3, 2011. We were down 19.4 percent and the threshold is traditionally a 20-percent decline on a closing basis. But either way, the market still does well a year after enduring a very severe correction, which is a decline of between 15 percent to 20 percent.
EQ: Depending on what stage of the bull market we are in, should investors consider shifting towards more defensive sectors versus cyclical sectors?
Stovall: In addition to the market’s performance itself, we also find that the sectors that tend to do the best in year one are definitely cyclical sectors. So Consumer Discretionary was among the best performers, as well as Industrials and Information Technology. All three posted average increases in excess of 40 percent since 1970, which is as far back as I am able to crunch sector-level data. In that same time, the market itself increased a shade below 35 percent in that first year. Yet in the fourth year, the market gained a shade less than 10 percent, which is again less than one-third of what it typically gains in the first year. The leading sectors were not your cyclical sectors, but rather such sectors as Consumer Staples, Telecom Services, Healthcare and Materials. So three of the four leading sectors were defensive in nature.
EQ: What other metrics aside from the S&P 500’s performance can investors pay attention to in order to try to gauge what phase of the bull market we are in?
Stovall: Those who believe that we might be in the early stages of a new bull market are indicating that the S&P 500 did slip below 20 percent on an intraday basis rather than just looking at a closing basis. Also, if you take a look at many other indices, both domestic and global, the S&P MidCap 400 and S&P SmallCap 600 declined by more than 26 percent each. The S&P Developed ex-U.S. Broad Market Index declined nearly 28 percent, whereas the S&P Emerging Broad Market Index fell almost 32 percent.
So if the rest of the world slipped into a bear market and we did too, at least on an intraday basis, then we are possibly in the beginning of a new bull market. But whether we’re about to enter year one officially, or just recover sharply from a severe correction, the performance of the market and its sectors are likely to be fairly similar to year-one performances. When the market experiences a decline in excess of 15 percent, yet we still do not call a bear market, the 12-month returns are close to a 30-percent gain on average. So even if it might not be labeled a brand new bull market, it typically feels like it.
Another metric that you can look at are valuations of stocks. On average, the first year of a new bull market is when you typically see the lowest P/Es for the market. Then as investors get a little more excited about the prospects of the economy and are more willing to buy into equities, we start to see some P/E expansion, but that happens relatively quickly. On average, going back to WWII, the P/E on as-reported-earnings was less than 14 at the beginning of bull markets, and yet averaged 18 at the end of year one. In year two, we averaged 16.5, then 15.5 in year three, and then back to around 16.5 in year four. So if investors don’t jump back into stocks soon, then they probably will be buying in after much of P/E expansion has already occurred. After that, we’ve pretty much hovered within a 1 or 2-percentage point range as we remained in a bull market mode.
