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Broad S& P 500 Hits Record High
Market Slowly Recovers From Tech Bust

By Tomoeh Murakami Tse
Washington Post Staff Writer
Thursday, May 31, 2007

NEW YORK, May 30 -- The Standard & Poor's 500-stock index hit a record high Wednesday, marking a four-year recovery of U.S. stocks battered by the burst of the tech bubble, the collapse of Enron and WorldCom, the Sept. 11, 2001, attacks and the wars in Afghanistan and Iraq.

The S&P 500 is in many ways the most important of the major indicators because it includes a broader range of stocks. It reached its previous high of 1527.46 on March 24, 2000, at the end of the tech boom that had investors, from the big guys on Wall Street to college students on laptop computers, snapping up shares of Silicon Valley wonders that proved too good to be true. The S&P 500 hit bottom, at 776.76, on October 9, 2002. It has been a long recovery since.

"It's nice to finally get the S&P to a post-bubble, new high," said Andrew Brooks, head of stock trading at T. Rowe Price. "We're quietly but deliberately doing very well. And investors who have stayed the course are enjoying the benefits."

The new closing record of 1530.23 comes seven months after the Dow Jones industrial average, another closely watched measure, surpassed its high. The Dow closed Wednesday at 13,633.08, 16 percent above its previous peak in January 2000.

The Nasdaq composite index finished at 2592.59, up 20.53, or 0.8 percent, for the day -- about half of its 2000 peak of 5048.62.

The Dow makes flashy headlines, but it is the S&P that professional investors follow most. It tracks 500 widely held U.S. companies across all sectors, making it a more reliable indicator of the overall health of the market. The Dow covers just 30 blue-chip stocks, and the Nasdaq is tech-heavy. Many brokerage firms offer mutual funds that try to mimic the S&P's performance, and more than 1,200 stock funds -- with assets of $2.31 trillion -- measure their performance against the S&P, according to Morningstar, an independent investment research firm.

The index's climb back to the top began in earnest in 2003, as decent corporate earnings and a reviving U.S. economy persuaded some investors to return to the stock market. Although domestic profit growth has slowed in recent months, a robust global economy has helped large companies beat analysts' expectations, propelling stocks higher this earnings season.

Stocks have rallied on a relentless stream of corporate dealmaking, which has been helped by historically low interest rates and a global market awash in cash.

The question, of course, is where the market is headed. Will it keep rising? Or will it be followed by a devastating fall like the one that ended the previous boom?

Market bears -- and there are still many out there -- say the current boom is looking uncomfortably familiar. They say that investors, complacent from years of low volatility, are piling onto stocks because they don't want to miss out, not because the stocks are solid, long-term investments.

"There are 7 1/2 'buys' for every one 'sell,' " said David James, senior vice president of James Investment Research, referring to the large number of favorable ratings that analysts have assigned to companies. "That basically says to us there's too much love. . . . It's not as overdone as before, but I do think these stocks are becoming expensive. And we do think we are due for a good-sized correction."

One sign that skepticism abounds beneath the surface is the high level of short positions -- orders placed by those betting stock prices will fall. Last week, the New York Stock Exchange said short interest rose to a record high in May. Short-sellers sell borrowed shares, buy them back when prices fall, return those shares to the lender and pocket the difference.

Market analysts are also worried about high energy prices heading into the summer driving season and about a geopolitical flare-up triggering a prolonged sell-off in a market that has not seen meaningful profit-taking in months.

Still, other market observers argue that the present stock values are justified. They point out that if inflation was taken into account, the S&P would have to rise 300 more points to match its all-time high.

Those analysts portray the tech boom and the current boom as a tale of two markets. Back then, they say, it was all about tech stocks. Companies that added ".com" to their names had their shares surge, and Internet firms with no business plan and negative earnings rose with the tide.

But this time there is not a single sector driving the boom. In fact, all but two of the 10 S&P sectors are above their previous highs. Energy, materials, consumer staples and the financial sector stocks are up at least 50 percent. Slowing the index's recovery are technology and telecom, down 61 percent and 43 percent, respectively, from a March 2000 peak.

Stocks are much cheaper than they were during the tech boom. S&P 500 companies are trading at about 17 times their earnings, compared with 28 in early 2000, said Howard Silverblatt, senior index analyst with Standard & Poor's. If companies were trading at those levels now, the index would be at 2364.

"Where we stand now is significantly different than where we stood in the year 2000," Silverblatt said. "We were overpaying back then on promised earnings, and people are a lot more skeptical now. It's more 'show me the money, show me the earnings, and I'll show you a trade.' "

Corporate balance sheets are also in better financial shape. S&P 500 companies have nearly 6 percent of their market value in cash, compared with 2 percent in the prior boom, Silverblatt said.

Many firms have been using that cash to buy back stock in record volumes. That helps companies improve their earnings per share by reducing the number of shares available. In 2006, S&P 500 companies spent $432 billion on buybacks, compared with $349 billion the previous year, according to the S&P. In 2000, that figure was $151 billion.

Perhaps more than anything, the flurry of corporate acquisitions driven by private-equity firms has been reducing the supply of stocks. Such firms take companies private with significant amounts of borrowed money, using assets of the target companies as collateral.

Last year, $1.49 trillion worth of mergers and acquisitions was announced in which the target was a U.S. company, according to Dealogic, a data services firm. That is up from $1.18 trillion in 2005, and the trend has shown little sign of slowing down this year. Meanwhile, initial public offerings on U.S. exchanges, though inching up in recent years, are at half of the levels of the tech boom era, Dealogic said.

Fueling the demand for stocks is the lack of attractive investing alternatives. The low-interest rate environment has diminished returns for money markets, bonds and other non-stock investments. The end of the real estate boom has also produced millions in speculative dollars that suddenly had no place to call home.

"There is a huge amount of money looking for places to invest, and that's really facilitated the whole process," said Mark Coffelt, chief investment officer of Empiric Funds. "There really aren't any alternatives."

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