Is this bull market for real?

NEW YORK (Reuters) – The S&P 500 has doubled from lows reached in March 2009 but the jury is still out on whether this is a true U.S. bull market.

Rallies are said to undergo five stages: displacement — such as a large injection of capital by the Federal Reserve — boom, euphoria, profit-taking and panic. With the S&P at twice the 666.79 value hit in March 2009, there’s no doubt markets are experiencing the boom. What is troubling investors are inflation pressures and high unemployment that could squeeze growth and margins.

Originally, many thought this rally was simply an interruption in an ongoing bear market that began in 2007. But as the gains mounted, most prominent analysts started to see it as the nascent stage of a longer-term, « secular » bull market. A secular bull market is one where the prevailing trend is for higher prices, with short corrections interrupting it, much like the long-running 1982-2000 period. There are recent converts to the secular bull market theory. Skeptics warn another bear market may be approaching. « If you’d had asked us in 2010 what kind of bull market we are in I would have been in the camp that it’s a cyclical bull, » said Thomas Lee, JP Morgan’s U.S. equity strategist, referring to a shorter rally that interrupts a long-term bear market. He believes the longer the rally lasts the greater the chances it will stretch for several more years.

Retail investors are more convinced of late. Domestic U.S. equities took in an estimated net $4.9 billion in the week ended February 9, according to the Investment Company Institute. U.S. equity funds have seen inflows for the last five weeks but that is still just a trickle compared to the years of outflows since the financial crisis. By Lee’s reckoning, if the rally lasts three years — it is now in its twenty-fourth month — history shows it will rally for at least another year. As a result, he is advising clients to focus on stocks with low price-to-earnings ratios that could rally in coming years, providing solid capital gains. In contrast, David Rosenberg, chief economist and strategist at Gluskin Sheff & Associates, is stressing capital preservation in what he has called an astonishing bear rally. Rosenberg says the economy and equity markets have been artificially stimulated by « so much tape and glue from the Fed, Treasury, White House, and Congress. » In a recent comment, he said investors should look for interim corrections to add exposure, but otherwise stick with sectors such as oil, large-cap blue-chips with low price-to-earnings ratios, and high dividends. Lee argues that the fastest recovery in profit margins for U.S. corporations since World War II points to a secular bull market rather than a cyclical one.

« We don’t think we’re going to have a bear market this year, » he said, citing the historical strong performance of equities in the third year of a U.S. presidential cycle. One of the big « ifs » to the secular bull thesis is the potential for rising interest rates to hit stock valuations, which makes fixed-income assets more attractive and chokes off access to capital. Just two primary bond dealers are expecting interest rates to rise this year and about half are expecting them to rise in the second half of 2012, according to a Reuters poll. However, federal-funds futures have been falling over the last week, showing investors have been bringing forward expectations for the first interest rate hike. « It’s very clear that short-term interest rates just mathematically cannot fall further so we’re not going to have that incredibly powerful support for equity markets this time around, » said Alan Brown, chief investment officer at Schroders, at a recent press conference. So before jumping in with both feet, investors may do well to familiarize themselves with the five stages of grief: denial, anger, bargaining, depression, and acceptance, because another bear market may be just around the corner.

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