When to Get Back in the Market

This spring, the S&P 500 rose more than 30 percent, confronting investors with a familiar conundrum: Was this a sucker's rally, or a long-lasting upturn?

To answer that question, some analysts looked beyond short-term price increases to study what they call the market's breadth. Jeff Rubin, director of research for Birinyi Associates, says that when rallies are broad-when they involve more than one sector of the economy-they're more likely to forecast a more sustainable bull market and an overall turnaround. Rubin points to rallies in 1975 and 1982 that turned out to be harbingers of bigger recoveries that followed. The good news is, this spring's rally was encouragingly broad. Indeed, according to data from research firm Morningstar, 10 of the 12 main industry sectors saw their stocks rise during that three-month stretch, with sectors like consumer services, industrial materials and media leading the way. The surge also stands in sharp contrast to an earlier, narrower rally from November through January, which focused mainly on financial stocks-and didn't last. If Rubin's historical pattern repeats itself, investors have reason to feel optimistic.

Thinking about breadth can also help investors ride out a downturn-because when a stock decline is "narrow," that's good news for stocks. This March, the major stock indexes hit 10-year lows. But as Paul Hickey, cofounder of the money-management firm Bespoke Investment Group, points out, only 36 percent of individual stocks reached new lows-a sharp contrast to last October, when 80 percent of stocks had that ugly distinction. The March figure was a sign that, instead of throwing the baby out with the bathwater, sellers were making reasonable decisions, company by company, says Liz Ann Sonders, chief investment strategist at Charles Schwab. And that suggests an absence of panic and a healthier climate for stocks.

Many money managers would rather base their get-back-in decisions on a more traditional measure-whether stocks in general are cheap. To gauge this, investors often rely on the price/earnings ratio, which compares a company's stock price to its profits. But Charles de Lardemelle, a relatively bearish value investor and comanager of the IVA Funds, says the ratio can be deceptive, because it doesn't let investors judge profit trends over time. He prefers to compare corporate profits to the U.S. gross domestic product, which measures the total output of the country's economy. Profits currently stand at 7 percent of GDP; de Lardemelle expects the figure to get down to 4 percent before the economy and the market see the potential for a sustained turnaround.

What to watch: Stock prices across different sectors of the economy.

Where to get them: http://news.morningstar.com/stockReturns/CapWtdSectorReturns.html