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Archive for Monday, October 11, 2004

Oil casts long shadow as bull market enters third year

October 11, 2004

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— The bull market is entering its third year this week, but it may not be a happy birthday for investors.

Rising interest rates and decelerating earnings are likely to weigh heavily on stocks, and lofty energy prices could stifle whatever gains are left in the months ahead.

Oct. 9, 2002, was a gruesome day on Wall Street, with the major indexes striking five- and six-year lows on bearish brokerage reports. But it also proved to be a turning point for the Standard & Poor's 500. And seven months later when that index had risen 20 percent, the classic definition of a bull market, economists at S&P declared the bear market over and dated the start of the bull market to that October day.

On average, bull markets last about four-and-a-half years, but most turn flat or lower by the 36-month mark, according to research by S&P. Four of the 10 bull markets since 1942 crumbled by the end of their third year.

How is the market doing this time? During the first and second years of the current bull market, the S&P 500 registered gains of 34 percent and 8 percent, respectively, slightly lower than average, by historical standards. If the trend continues, this year will see substantially lower gains in the neighborhood of 3 percent or less.

"We think the market will continue to advance, but it's definitely time to adjust your expectations. It's not going to be a robust year," said Sam Stovall, S&P's chief investment strategist. "You know the old phrase about how 'the easy money has already been made?' That's true."

Investment strategies

For individual investors, that means things are about to get a bit trickier, Stovall said. You'll want to be more selective about which stocks you own, perhaps sticking with high-quality, large-cap issues, which may be more likely to pay dividends. You'll also want to keep a close eye on fees and expenses, which can take a formidable bite out of total returns in a flat market.

There are some things working in the aging bull's favor. With the continued support of consumer spending, the economy still is expanding, albeit at a slower pace than before, and an uptick in corporate spending could help drive growth. The thing that gives market watchers pause is that interest rates are rising just as corporate earnings are slowing. Individually, neither of these factors is likely to cause a steep decline, but together they don't create a great situation.

'Recession watch'

Not every decline leads to a recession, of course; some bull markets have experienced soft patches, but recovered before plummeting 20 percent, which marks the reversion to a bear market. But the beginning of the third year today puts many analysts on "recession watch," Stovall said.

To many observers, uncomfortably high oil prices seem a likely catalyst. Forecasters are predicting colder than average temperatures this winter for some southern states and much of the mid-Atlantic, which means consumers will be spending more on utility bills, as well as at the pump, and have less left over for other things.

Economic wild cards

Other potential pressures, such as the impact of a terror strike, are harder to foresee, more difficult to quantify and therefore more fear-inducing for investors. With the U.S. economy so dependent on oil from parts of the world beset by political and financial unrest, these factors also are difficult to ignore. Energy prices remain the wild card because they are most beyond our control.

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