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U.S. Stocks at New Record, Earnings Key For More Gains

By Markets Reuters

Despite the worst start to the year in history for U.S. stocks, the benchmark S&P 500 index rallied to a record intraday high on Monday, surpassing the previous intraday peak set on May 20, 2015. It if ends the day above 2,130.82 on Monday, the S&P 500 index will close at a record, confirming a rally that started on March 10, 2009 as the second-longest bull market in the index's history. In early trading, it was at 2,135.68, above the May 20, 2015 intraday high of 2,134.72.

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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. "When you look at the first five months of the year it has been an emotional roller coaster that has been beset with investor cognitive errors, most glaring of which was discounting the recession that never happened in January and February," said Julian Emanuel, equity strategist at UBS in New York.

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 that if the S&P 500 closes above its record finish of 2,130.82 set on May 21, 2015 that may spark another leg up in the market.

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 one, the index is up 91 percent of the time over the next year 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 for the year. Leading the market up since it bottomed in February have been names in the financial, energy and materials sectors, with energy and materials both up more than 20 percent and financials up 16.7 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.

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Profits may be showing signs of turning a corner, despite second-quarter earnings forecast to decline 4.7 percent versus a 5.0 percent decline 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 16.5 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 Lewis Krauskopf; Editing by Linda Stern and Clive McKeef)