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: In this week’s Sector Watch report, you discussed how the government shutdown thus far hasn’t seemed to impact the market’s trading volume or volatility based on data going back to 2000 for the month of October. Did this finding surprise you?
Stovall: Actually, I did not really expect to be surprised because we’re only dealing with 10 trading days, which was over a two-week period. So unless we had tremendous spikes upward in either volume or in volatility, or everybody basically staying on the sideline, the numbers that I came up with was pretty much consistent with the volume that we had seen throughout all of 2013, as well as both the volume and the volatility of intraday prices for these 10 trading days in October going back to 2000.
The original question was related to the absence of government-supplied economic data and what could that do to trading patterns, I think investors have been going through a bit of a whipsaw recently because of on-again, off-again agreements between the House of Representatives and the Senate. Still, it was not enough to really make a big change when you are looking at volatility and volume over an extended period.
EQ: Did the headlines coming out of Washington serve as a replacement of economic figures as tradable news, at least for the short term?
Stovall: I would tend to say, “Yes.” That’s a very likely possibility. The volatility that we would have received from daily economic releases was replaced by the daily uncertainty offered by the disagreements between the Democrats and Republicans in Washington. In a sense, what one took away, the other one replaced.
EQ: It’s only been two weeks, but the market has held up quite well thus far. Could we still see a potential pop if/when a resolution is announced soon?
Stovall: We already had a pop last Thursday when the S&P 500 gained more than 36 points, and we saw a pop on Wednesday when the S&P 500 gained by well over 1 percent. So it ends up being a nice little pop.
Will the market jump by more than 10 percent in the month following an agreement that has been established by both houses of Congress? I don’t really think we’re going to see that strong of an advance. We’re heading into the third quarter earnings reporting period, and the most recent estimate was for about a 2.7-percent increase. That’s down from the estimate as of October 1 of 3.4 percent. So either company managements are again doing a good job managing expectations, or we might end up seeing a little bit of a pause in year-over-year earnings growth this quarter. If so, investors will have to wait until early 2014 to become enthusiastic about earnings growth prospects once again.
EQ: Could the market potentially drop following a resolution announcement as traders “buy the rumor, and sell the news?”
Stovall: An immediate-term drop, yes. But something that’s meaningful that would last over several days, probably not. I think it would certainly take away the uncertainty that almost nobody can forecast, and replace it with forecastable uncertainty in the form of economic growth as well as earnings increases.
Let’s face it, valuations today are still appealing while not compelling. The price-to-earnings ratio on trailing 12-month earnings is still at about a 10-percent discount to the median to the past quarter century.
The P/E on projected 12-month earnings is still 8 to 9 percent below what the average has been since this secular bear market started in 2000. It points to a level of 1840 on the S&P 500 to be fair value should we go back to that 16 times projected operating results.
EQ: Earnings season has been largely overshadowed by politics thus far. It’s still early, but the beat rate seems weaker than previous years. Is this a possible cause for concern?
Stovall: With only 54 companies having reported, which is just a shade above 10 percent of the S&P 500 companies, we have a lot more companies to go before I’d get too worried about it. The beat rate usually has been 65 percent and right now we’re finding that 32 of these 54 have beaten estimates. That’s a 59-percent rate, which is less than the 65 percent average, as well as the 67 or 68 percent that we saw last quarter. But I still think it’s very early in the game.
EQ: Telecom is supposed to be the leader for Q3 earnings growth. Once that sector starts reporting in a more meaningful way, do you think that will help to even out the results?
Stovall: The Telecom Services group is expected to show the strongest increase, up more than 25 percent, primarily because Sprint (S) was removed from the index. The Telecom sector has a very small number of constituents to begin with, so removing Sprint leaves us with five or fewer in there. Most of the components are the behemoths of AT&T (T) and Verizon (VZ) , so I would say that you have to look at that 25-percent growth rate with a very big grain of salt because of the exclusion of Sprint having an outsized impact.