Each week, we tap the insight of Sam Stovall, Managing Director of US Equity Strategy for S&P Capital IQ, for his perspective on the current market.
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EQ: Revised GDP numbers for Q1 indicated a 2.9% decrease, which was drastically lower than previous estimates. As bad as that sounds, has the market already written off Q1 as a throwaway quarter at this point? Could it still weigh on the market going forward?
Stovall: I think that most people on Wall Street look to Q1 data as ancient history, and while the final number did come in weaker even than the second revision, I think most people project future economic reports to mask the musty odor of this aged GDP report.
I think the reason that the market responded positively to this economic data was because it was mostly already written off.
EQ: In this week’s Sector Watch, you noted that the media has focused maybe a little too much on the market’s record highs as a possible sign of a top. On the surface, it seems like a valid concern because new territory usually means going outside of your comfort zone. But do you think is this misguided for investors?
Stovall: Yes, I do. If you think about it, how did the S&P 500 go from a level below 14 back in June 1949 all the way to a level of 1964 on June 20, 2014, if it did not trade frequently in new high territory? How did we end up with an average annual increase of 8.5% if we were not at all-time high territory frequently?
So I wanted to quantify all of this, and I found that the S&P 500 on average traded in new high territory 7% of the time during all bull markets going back to 1949. If you believe that we are in the beginning of a new secular bull market, then I would say that chances are we have even longer to go because the average time for secular bull markets is 9% of all trading days in new high territory, and thus far in this bull market, we’ve experienced only 5%.
Also, right now, this bull market has been in existence for 63 months. The average secular bull market since World War II has last 64 months, so we’re pretty much on target with the average. We’ve had some bull markets last well over 64 months, such as the bull market from 1990 through 2000, which lasted 113 months. But just on the averages, it would suggest that we have a little bit more to go to the upside in terms of time as well as the percentage of trading days in all-time high territory.
EQ: We discussed recently that the bears may be running out of ammunition for this complacent market. In terms of investor sentiment, do we still have enough healthy skepticism?
Stovall: Yes, I think so. I don’t think this lack of love for this bull market will preclude a pullback or correction of 5% to 10%, or even 10% to 20%, but I think that because this bull market is so unloved, it probably will not lead to a bear market in terms of over-exuberance, extreme valuations, etc.
If you look to projected or trailing operating earnings, we’re pretty much trading on long-term averages. So should we fall into a bear market, I don’t think it’s because of valuations, it’ll be because of some exogenous event.
EQ: If stocks are currently fairly valued, and we’re expected to continue to hit new highs, do you expect fundamental growth to catchup or will investors push stocks into possibly overvalued territory for this to happen?
Stovall: Prices didn’t catch up to valuations until the end of 2013. If you look at both earnings increases and share price appreciation from the end of the prior bull market in the third quarter of 2007 to the end of 2013, you’d see price and earnings growth of 21% each. If you started at the trough of earnings and prices in 2009, and carried that out to the end of 2013, both advanced 173%.
So I think what’s going to be driving price appreciation in 2014 will be earnings growth. That’s why I think we’ll probably end up seeing a mid-to-high single-digit price appreciation for all of 2014, and a similar level of improvement in the coming 12-month period mainly because we started the year neck-and-neck in terms of price gains as well as earnings increases.