Bull Market Has Legs

 | Mar 26, 2012 | 11:30 AM EDT
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Decades of market data and trading history indicate that the current version of a bull market that is just getting started and could be here for another three years. Or depending on how you view things, the bull market has about a year left before losing steam. Market history shows that a typical bull market lasts about four years. The S&P 500 bottomed in March 2009 and many market observers contend that this is year three of a four-year stretch.

Yet last year, the market declined 19.6% between April and October, so others like to cite October 2011 as the beginning of a new bull market -- meaning that this version is just getting started. It's a hair-splitting difference. By definition, since the S&P 500 did not decline by 20%, the official determination of a bear market, then the bull market that began in 2009 is still intact.

Data junkies out there may want to consider that since October 2011, the S&P is up 27% since last October. On average, most bull markets begin with a first-year gain of more than 30%, so this version of the bull seems on its way to satisfying that condition. Further, as we've seen time and time again, smaller-cap stocks usually outperform other equity groups at the start of a bull market. Since October, the Russell 2000 index of small cap stocks is up nearly 40%, outperforming the S&P and even the Nasdaq.

Since October, when I discussed Builders FirstSource's (BLDR) merits as an excellent way to bet on even a modest housing recovery, the small-cap supplier of building materials to homebuilders is up a whopping 200%. By comparison, Lowe's (LOW) has moved up 50% during that time. Terex (TEX), which makes industrial construction equipment, is up more than 110% in the past six months while larger rival Caterpillar (CAT) is up around 45%.

Market researchers also like to point out that defensive market sectors such as health care and utility stocks typically outperform during the tail end of a bull market. So far those sectors have lagged, suggesting that this bull market has legs.

Of course, against these positive layers of market history is a still very weak U.S. economy, a European recession, and copious doses of monetary stimulus. Macroeconomic forces don't care about market history. More so, the ultimate predictor of any future return is starting point valuation. Back in 1982 when a historic bull market was about to begin, the S&P commanded a single-digit P/E ratio. Today, based on valuations using a 10-year average profit metric, the S&P stands at 20x earnings. There's also the apprehensiveness that comes along with the Fed maintaining historically low interest rates.

That being said, stock valuations still remain attractive if one pays attention to valuation. Boring Xerox (XRX) is pumping out enough free cash flow to retire 10% of its company each year, and the company is using that cash flow to buy back stock and pay a dividend. Value Line (VALU) yields 5%, carries no debt, and is rolling out an investment product for professionals that could reinvigorate growth.

Whether the bull market has one year left or three, investors can still find attractive valuations that will provide plenty of upside potential but pose little downside risk of a permanent capital loss. But one cannot deny that if the U.S. continues to mend, the outlook will indeed remain attractive.

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