By Chuck Mikolajczak
NEW YORK (Reuters) – Despite the worst start to the year in history for U.S. stocks, the benchmark S&P 500 <.SPX> index rallied to record highs on Monday, surpassing previous peaks set in May 2015 and confirming the rally that started on March 10, 2009 as the second-longest bull market in the index’s history.
The new record could point the way to an improved second half, if corporate earnings improve, analysts said.
The index closed at a record 2,137.16 on Monday. During the session, it rose as high as 2,143.16, surpassing the May 20, 2015 intraday high of 2,134.72.
To the surprise of many, the latest all-time high has come more than a year after U.S. stock prices peaked and after the market has withstood several consecutive quarters of contracting U.S. corporate earnings and global market volatility.
Declining earnings, stagnant overseas economic growth, a plunge in oil prices, negative interest rates in some countries, the threat of interest rate increases from the U.S. Federal Reserve and a recent spate of panic selling following Britain’s vote to withdraw from the European Union have all undermined the bull market in the past year.
Investors opened 2016 with concerns about Chinese economic weakness, a free fall in oil prices and fears of global recession.
By early February, the S&P 500 index was down 15 percent from its highs, and traders were talking about the possibility of a bear market, traditionally defined as a 20 percent fall from their highs.
U.S. stock prices fell to 3-1/2 month lows on June 27, as the surprise vote by United Kingdom voters to withdraw from the European Union, or Brexit, brought about another wave of uncertainty for investors, before the recent rally of nearly 7.0 percent.
THE NEXT LEG
The question now is whether the market can advance notably beyond this point. Some strategists believe the S&P 500’s close above its May 21, 2015, record finish of 2,130.82 could spark another leg up in the market.
“It bodes well for the second half. In general when the market can make new highs and … (as) earnings are going to start to improve, the combination is going to give investors more confidence about more equity exposure in the second half,” said Thomas Lee, managing partner at Fundstrat Global Advisors in New York.
“I think there’s still plenty of room for the market to gain,” said Lee, who has a 2,325 year-end target on the S&P 500.
The long gap between new records is also a bullish signal for stocks, according to Bank of America Merrill Lynch technical research analyst Stephen Suttmeier.
He noted in a recent report that when the index hits a 52-week high 300 or more calendar days after its previous high, over the next year the index has been up 91 percent of the time, with an average return of 15.6 percent.
Also positive for stocks is the breadth of the current rally. Though the S&P 500 rose in 2015, it was on the strength of a handful of companies, while in 2016, more than 300 stocks are in positive territory and the S&P 500 is up 4.5 percent for the year so far.
On Monday, S&P 500 consumer staples <.SPLRCS> and industrials <.SPLRCI> indexes hit intraday records as well. Though they ended lower on Monday, the more defensive S&P utilities <.SPLRCU> is still among the best-performing sectors for the year so far, hitting a record high last Wednesday.
Leading the market up since it bottomed in February have been names in the financial <.SPSY>, energy <.SPNY> and materials <.SPLRCM> sectors, with energy and materials both up more than 20 percent and financials up more than 17 percent.
And the outperformance of those sectors is a sign that the profit cycle is resuming after an expected fourth quarter of declining earnings, said Richard Bernstein, chief executive officer of Richard Bernstein Advisors in New York.
Profits may be showing signs of turning a corner, despite second-quarter earnings forecast to decline 5.0 percent versus a decline also of 5.0 percent in the first quarter, with a return to growth anticipated throughout the second half of the year, according to Thomson Reuters data.
Earnings would have to grow to normalize the currently heady valuations of S&P 500 companies. These companies are selling at an average of 16.8 times their expected earnings over the next 12 months. That’s above the long-term average price/earnings ratio of 15, and that may be making investors skittish.
There are other reasons why the rally may not hold. The United States could remain in a slow-growth environment and economic data could easily start to sag again. The upcoming U.S. election could bring about additional volatility, and the logistics of Brexit could bring about additional uncertainty.
“Investors are just whistling past the graveyard here. There is a lot of ugly stuff on the horizon that everyone is just sort of ignoring,” said Phil Orlando, chief equity market strategist, at Federated Investors, in New York.
(Additional reporting by Caroline Valetkevitch, Trevor Hunnicutt and Lewis Krauskopf; editing by Linda Stern and Clive McKeef)