How Long Will the Bear Growl?

07/24/2008 12:00 am EST

Focus: MARKETS

Sam Stovall

Chief Investment Strategist, CFRA Research

Sam Stovall, chief investment strategist for Standard & Poor’s, says we’re about two-thirds through this bear market and he recommends a couple of sectors.

Standard & Poor’s Investment Policy Committee (IPC) regards a 20% decline in price from the peak of the bull market [as] a bear market. We have had nine bear markets since 1956, from the decline of 20% in 1990,to the 48.2% [decline] from 1973 to 1974,and 49.1% from 2000 to 2002.

Many investors have begun to ask what happened to the price of the S&P 500 after the index fell 20%. The S&P 500 didn’t cross the 20% threshold until two-thirds of the way through the overall decline. From 1956 to 2001, these nine bear markets lasted an average 14 months, yet it wasn’t until the ninth month after the market top that the S&P 500 finally fell into bear market territory.

This time was the same as the average: We topped out on October 9, 2007, and crossed into bear market mode almost exactly nine months later. As a result, the IPC voted to reduce its year-end target for the S&P 500 to 1390 from 1490.

However, the IPC did not alter its recommended asset allocation, which remains at 45% US equities, 15% international stocks, 25% bonds, and 15% cash in the moderate ETF portfolio. The 1390 target, while 5% below the 2007 close of 1468, is nearly 10% above the July 3rd closing level of 1263.

[We also] raised the recommended weighting of the S&P health care and utilities sectors to market weight from underweight, and reduced the recommended exposure to the consumer discretionary and industrials sectors to underweight from market weight.

With equity volatility likely to remain high and much of the bad news already discounted, we think investors will refocus on health care’s defensive qualities, allowing for better relative performance. The group is currently trading at 13.7x 2008 estimated earnings, a discount to the S&P 500’s 14.4x multiple. 2008 estimated earnings [are] expected to rise 11% vs. 6.4% for the 500.

We like the utilities sector for its defensive characteristics. Also, S&P equity analysts expect 12% growth in earnings, and the sector had an above-average 3.2% dividend yield as of July 8th.

Since we expect consumer-spending growth to slow to 0.3% in 2009 from projected 1.7% growth in 2008 and 2.9% in 2007, we downgraded the consumer discretionary sector. Higher energy prices, lower consumer confidence, and eroding earnings estimates give us little reason to believe this group will stage a sustainable rally.

Finally, we downgraded the industrials sector. With the US economic slowdown accelerating and mid-cycle slowdowns now under way in Europe, the UK, Canada, and Japan, we believe this cyclical sector is vulnerable as investors increasingly question its future earnings growth outlook.

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