Each week, we tap the insight of Sam Stovall, Chief Equity Strategist for S&P Capital IQ, for his perspective on the current market.
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EQ: The S&P 500 has bounced 4.5 percent from the recent low of 1741. Many investors and definitely traders, may be wondering if we’re out of the woods or if this is a sucker’s rally. Where do you stand on this right now?
Stovall: Our belief is that it’s not a sucker’s rally and that we are expecting the S&P 500 to get back to break-even probably within the normal time period of less than two months.
My feeling is we will probably end up getting back to break-even a little bit quicker than history would suggest since we’ve already recovered 75 percent of what we lost in only four days.
I think that we then work our way higher to challenge the 1900 level on the S&P 500 before we have to worry about a second decline, and possibly a deeper one.
EQ: Given that we are trading around, if not slightly above, the low-1800 level that you discussed in this week’s Sector Watch report, how should investors prepare to either capitalize on the possible breakout higher or mitigate downside exposure if there is a breakdown lower?
Stovall: Well, we’re not short-term timers, but our belief is that the market will work its way to the all-time high and then establish new highs. If, however, we’re wrong and the market does resume its decline, we’ll likely be no worse than a correction (a decline of 10 to 20 percent), and historically it only takes us only four months to get back to break-even.
But I would encourage investors to not go too far out on the risk curve even if they’re anticipating we do eclipse the 1900 level because if we don’t, they’ll probably end up letting their emotions cause them to sell out just as we’re probably ready to turn around once again.
So I would say for traditional investors to use 5-percent decline thresholds as buying opportunities, and not as reasons to get increasingly concerned.
EQ: You also mentioned that the current duration the market took to hit pullback territory is right in line with the historical average for bear markets. If we were to enter a bear market, there would most likely need to be a fundamental factor driving the selloff, correct? What are some things that could serve as that bearish catalyst?
Stovall: The speed with which this decline occurred does not make me feel any better that it will only be a pullback because many of the bear markets occurred when the number of days it took to eclipse the 5-percent decline threshold was more than 10 but less than 40. That said, I think that we really don’t know why the market would slip into a decline of 10 percent or more.
Most of the stones in the current wall of worry have been with us for a while and as a result, I think they have already been factored into share prices. I think we would need to get some unanticipated event to occur that would cause investors to once again think that it is a game-changer, and as a result, cause them to bail out of equities. I really don’t know what is currently on the horizon that could scare investors sufficiently to believe that it’s time to bail out of stocks.
EQ: Looking at Q4 earnings, the majority of the S&P 500 companies have reported and it looks like it’s shaping out to be a pretty strong quarter so far. Have the numbers been encouraging for the period?
Stovall: The fourth-quarter earnings have been encouraging. We’re looking at a 7.6-percent year-over-year increase versus the initial expectation for a 5.7-percent gain. What is a bit disconcerting, however, is that the first-quarter earnings results, combined with the full-year 2014 estimates, have been coming down. In particular, first quarter 2014 is now expected to record a 1.9-percent increase as compared with the initial estimate of 5 percent. For all of 2014, we’re now looking for 8.3 percent versus the original estimate of 10 percent.
These lower revisions certainly are a concern, especially considering how early in the year they have materialized. One could blame that either on weather or on management, but I tend to think that we definitely need to keep an eye on earnings growth. Our belief is that with economic growth now likely to be at 3 percent versus our earlier estimate of 2.8 percent for 2014, combined with our less than 2-percent expected gain for all of 2013, I would think that an improvement in GDP growth would also lead to at least a stabilizing, if not, a re-incline of earnings expectations.