BT: Is the rally in blue-chip stocks for real? (14 May 2008)

Is the rally in blue-chip stocks for real?

To know that, investors need to look for future signs

(NEW YORK) In fits and starts, blue-chip stocks have been climbing higher since mid-March. But many market watchers aren't convinced that the worst of this market storm, which began in October, is behind us.

'This was certainly a market bottom, and a pretty good market bottom,' said Duncan Richardson, chief equity investment officer at Eaton Vance, the asset management firm in Boston. 'But I don't know if it was the bottom.'

For that, investors will have to look for signposts in the future - not the past.

For instance, if stocks are rallying on the belief that the economy is indeed on the mend, investors will need to see signs that it is actually strengthening. 'There's been a lot of stimulus put into place, and you've got to look for evidence that that's working,' Mr Richardson said.

One important gauge will be corporate earnings - namely, profits among companies outside the financial services sector.

'The world has figured out that the financial sector has serious problems, but the assumption is that the rest of Corporate America seems to be doing OK,' said Ben Inker, director of asset allocation at GMO, an investment management firm in Boston.

While overall earnings of the Standard & Poor's 500-stock index are expected to fall nearly 6 per cent in the second quarter, profits for the nine nonfinancial sectors are predicted to rise nearly 8 per cent.

But can investors count on this trend continuing?

'It's our significant worry that corporate profits in the nonfinancial part of the system are likely to be weak over the next couple of years,' Mr Inker said. 'If we're right, and corporate profits are going to start to deteriorate outside the financials, it will cause another round of problems.'

Here are some other factors to watch in coming weeks:

An indication that investors are gaining courage after a market scare is a renewed willingness to own speculative assets.

Small stocks generally perform better than large capitalisation shares in the first few months of market recoveries. Since 1979, for example, the median gain for small stocks in the three months after market bottoms, has been 19.6 per cent, according to a study by Ned Davis Research. By comparison, big, blue-chip shares have risen more modestly - by 13.6 per cent.

Since March 17, the S&P 600 index of small stocks has gained 9.3 per cent while the S&P 500 index of large stocks is up 8.8 per cent.

Continuing strength in small stocks through June could offer confirmation that this rally is for real.

As markets recover from severe downturns, 'growth stocks eventually come back into favour', said Robert Turner, chairman and chief investment officer at Turner Investment Partners in Berwyn, Pennsylvania.

Because growth stocks are considered a more aggressive bet than dividend-paying value shares, a growth rally is an indication that 'the sellers are done selling and the buyers are ready to come in', Mr Turner said.

Since mid-March, growth stocks in the Russell 1000 index of blue-chip stocks are beating their value counterparts - but by less than a percentage point. So this indicator is sending mixed signals for the moment.

If markets are rallying because the economy is on the mend, it stands to reason that the most economically sensitive stocks should fare best after a market bottom\. \-- NYT


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