Some Sectors Bounce Back Better

10/31/2011


Bear markets are like the flu or bad weather. You can't avoid them forever, and the effects are uncomfortable. But bear markets also resemble those afflictions in another way — they don't last forever, and their passing tends to leave us invigorated.

Stocks tend to rise sharply after bear markets. And since timing the exact bottom is extremely difficult, the Forecasts prefers to remain at least partly invested in all markets, the better to profit from the inevitable upward move. The market's long-run trend is higher, and investors bet against that trend at their peril. Since 1950, the S&P 500 Index has risen at an annualized rate of 7.2% excluding dividends, posting gains in 45 of the 61 calendar years. Since the end of World War II, the 15 Dow Theory-indicated bear markets have averaged 14.5 months, about 38% as long as the average bull market of more than 38 months.

Not only do we remain invested during bear markets, we don't go completely defensive with our portfolio, loading up on noncyclicals. Why not? Because sectors that perform poorly during bear markets often lead the way during the ensuing bull market. 

During the 12 months after the last two completed bear markets (ending in October 2002 and March 2009), the S&P 500 consumer discretionary, financials, materials, and technology indexes were among the top five performers of the 10 sectors. In contrast, consumer staples, energy, health care, and telecom lagged the broader market during both rallies. Those numbers, illustrated in the nearby tables, should not entirely surprise us, as the sectors that set the pace during the bounceback tend to be more sensitive to changes in the business climate.

BEAR MARKET 3/24/00 TO 10/9/02
Bear-
Market
Price Chg.
(%)
Price Change After Bear Market Ends
Sector Index
3
Months
(%)
6
Months
(%)
Change
(%)
Rank
Consumer Discretionary
(41.6)
10.6
11.5
38.1
4
Consumer Staples
20.6
(0.2)
(6.8)
4.1
10
Energy
(21.2)
6.7
5.6
18.4
8
Financials
(23.6)
23.9
16.8
43.1
3
Health Care
(8.7)
6.0
5.1
9.6
9
Industrials
(37.3)
16.3
11.5
34.4
6
Materials
(26.5)
20.9
11.7
37.8
5
Technology
(81.1)
37.7
27.8
77.7
1
Telecom Services
(74.1)
40.8
10.5
22.0
7
Utilities
(49.0)
34.1
21.9
45.2
2
S&P 500 Index
(49.1)
17.1
11.5
33.7
BEAR MARKET 10/9/07 TO 3/9/09
Consumer Discretionary
(58.0)
50.8
65.7
99.1
2
Consumer Staples
(31.5)
21.9
28.9
41.4
7
Energy
(47.3)
28.4
28.9
39.0
8
Financials
(82.4)
98.9
129.4
145.4
1
Health Care
(39.9)
16.3
29.9
45.5
6
Industrials
(64.9)
55.6
67.6
96.0
3
Materials
(59.3)
50.4
67.9
82.8
5
Technology
(53.1)
44.0
62.5
83.9
4
Telecom Services
(50.4)
15.4
19.0
20.0
10
Utilities
(45.4)
19.3
28.5
32.6
9
S&P 500 Index
(56.7)
38.8
51.6
68.6

So which sectors will lead the rally after the bear market that began this spring? It's impossible to know for sure, and it's possible an enduring bounceback has already begun. The S&P 500 Index has risen 12% from its Oct. 3 lows, and the sectors leading the charge include some names prominent during previous rallies.

The five best-performing sectors, all up at least 14% since Oct. 3, include consumer discretionary, financials, materials, and industrials. We would expect these four economically sensitive sectors to benefit from an upward market move. The other top performer, energy, has historically not paced the market during bouncebacks. Energy, however, tends to follow its own path, beholden as much to commodity prices as to the fortunes of the broader market.

In the table below, we present 12 Buy-rated stocks from sectors likely to outperform in the first year of the next bull market. Three are reviewed below:

Bed Bath & Beyond's ($61; BBBY) mix of housewares and appliances keeps customers visiting even during difficult times. Quarterly revenue rose in 12 of the last 14 quarters, with the only declines coming in late 2008 and early 2009, when sales fell less than 1%. Since the November 2009 quarter, same-store sales have risen at least 5.6% in every quarter, while per-share profits jumped at least 30%, driven by both widening profit margins and aggressive stock buybacks. Despite that superior growth, Bed Bath & Beyond trades roughly in line with the median specialty retailer at 17 times trailing earnings.

The consensus projects per-share-profit growth of 17% in the second half of fiscal 2012 ending February and 15% growth in fiscal 2013. Bed Bath & Beyond has topped the profit consensus by at least 10% in each of the last four quarters, and analyst estimates are on the rise. Given that growth potential and earnings-estimate momentum, Bed Bath & Beyond looks cheap at 14 times the fiscal 2013 estimate. The retailer's shares have held up better than most, rising 24% for the year and hitting an all-time high earlier this month. Bed Bath & Beyond stock is a Focus List Buy and a Long-Term Buy.


CF Industries ($158; CF) stands tall in the materials sector. The company, which manufactures and distributes nitrogen and phosphate fertilizers, earns the maximum Quadrix Overall score of 100, buttressed by 100 in both of our sector-specific scores. CF Industries is benefiting from overseas growth and rising farm income in the U.S. Looking ahead, an expanding global population and increasing consumer wealth bode well for CF. With many emerging markets still underserved agriculturally, the quest for higher crop yields should support increased sales of fertilizer in coming years.

For full-year 2011, Wall Street targets per-share earnings of $21.45, up from a consensus of $16.61 three months ago. Revenue should approach $6 billion. Last year, CF earned $7.63 per share on sales of $3.96 billion. A rise from today's unusually low prices for natural gas — a principal raw material used to produce fertilizer — and highly cyclical demand represent potential threats. Still, expectations for CF appear modest, and the stock trades at a reasonable 11 times trailing earnings. Wall Street expects roughly flat sales and 6% lower per-share profits in 2012, a target that could prove conservative. CF Industries, with a Value score of 89, is a Focus List Buy and a Long-Term Buy.


The market's unenthusiastic response to Microsoft's ($27; MSFT) solid September quarter reflects continued worries about slowing personal-computer demand and the company's lack of significant new products until next year's Windows 8. But Windows 8 could be a game-changer, blending elements of the software giant's classic PC operating system with its Windows Phone 7 program to better compete with mobile-device offerings from Apple ($398; AAPL) and Google ($583; GOOG). While Windows 8 isn't expected to fully launch until late next year, beta versions available much earlier could become a catalyst for Microsoft, increasing investor interest in the shares and restoring confidence in the company's ability to innovate.

The software giant earned $0.68 per share in the September quarter, up 10% and in line with expectations. Sales rose 7%, powered by gains at all five divisions, including 2% growth for the Windows operating system, the unit most dependent on PC demand. At 10 times trailing earnings, Microsoft trades at a 30% discount to its peer group and a 22% discount to its own three-year average. That valuation reflects low market expectations — per-share-profit growth of 6% in fiscal 2012 ending June and 10% in fiscal 2013. However, Microsoft expects its acquisition of Skype, completed earlier this month, to create new revenue streams from advertising and premium services. Even a modest dose of good news could inject new life into this Buy and Long-Term Buy.

SCREEN OF THE MONTH: STOCKS FROM RALLY-FRIENDLY SECTOR
All 12 of the stocks below are rated Buy. We screened for stocks scoring above 80 in Quadrix Overall, 12-Factor Sector, and Reranked Overall, sticking to sectors that have historically performed well after bear-market periods.
Year-To-Date
Return
Return From
April 29 Peak
Return From
Oct. 3 Bottom
Sector Scores
Company (Price; Ticker)
Stock
(%)
Relative
To S&P
500 Sector
(%)
Stock
(%)
Relative
To S&P
500 Sector
(%)
Stock
(%)
Relative
To S&P
500 Sector
(%)
Overall
Quadrix
Score
12-
Factor
Sector
Reranked
Overall
Sector
Advance Auto Parts
($64; AAP)
(3.9)
(8.1)
(2.9)
1.0
12.9
(2.2)
91
91
88
Cons.
Discretionary
Aflac ($42; AFL)
(26.0)
(7.5)
(25.7)
(5.0)
24.3
9.2
96
95
99
Financials
Alliance Data Systems
($99; ADS)
39.3
37.1
4.2
8.0
12.4
0.5
90
86
86
Technology
Apple ($398; AAPL)
23.3
21.1
13.6
17.4
6.2
(5.7)
100
100
99
Technology
AutoZone ($328; AZO)
20.3
16.1
16.1
20.0
5.1
(9.9)
93
89
98
Cons.
Discretionary
Bed Bath & Beyond
($61; BBBY)
24.2
20.0
8.7
12.6
10.4
(4.6)
94
100
99
Cons.
Discretionary
CF Industries ($158; CF)
16.8
29.4
11.6
29.2
30.5
14.0
100
100
100
Materials
Google ($583; GOOG)
(1.8)
(4.1)
7.2
11.0
17.7
5.8
98
96
96
Technology
MasterCard ($328; MA)
46.1
43.9
18.7
22.5
5.3
(6.5)
92
92
94
Technology
Microsoft ($27; MSFT)
(3.9)
(6.2)
3.4
7.2
9.3
(2.6)
98
96
99
Technology
Newmont Mining
($65; NEM)
5.6
18.1
10.6
28.3
2.5
(14.1)
96
94
96
Materials
Oracle ($32; ORCL)
3.4
1.2
(10.0)
(6.2)
15.9
4.0
97
81
94
Technology
Note: Quadrix scores are percentile ranks, with 100 the best.

 


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