Each week, we tap the insight of Sam Stovall, Chief Equity Strategist for S&P Capital IQ, for his perspective on the current market.
EQ: February was anticipated to experience a slight pullback in order for the market to digest the gains from January and since bouncing off the October lows. Are you surprised that the market actually performed pretty well this month instead of experiencing a decline?
Stovall: You could say that I was surprised, because historically, February has been a month in which the market digests the gains from November, December and January. It is also probably why February is the second worst-performing month for the S&P 500 only behind September. Yet, the market has declined 49 percent of the time in February, which obviously means that it has risen 51 percent of the time. So I guess shouldn’t be too surprised. Also, there’s a question as to whether we’re in the beginning of a new bull market or the continuation of a near three-year bull market. So I would tend to say that the market right now has a lot of momentum behind it, but it won’t go up forever. It will eventually experience some sort of digestion of these gains, it just didn’t happen in February.
EQ: As you noted a few weeks ago, occasional periods of digestion helps to avoid indigestion. So could February’s positive performance be a cause for concern that the market may be overbought?
Stovall: The market should have some sort of digestion of gains, but let’s face it, interest rates are still very low, valuations and P/E ratios still look attractive by historic standards, and a lot of the technical indicators–be they sentiment, stochastics, or other more esoteric measurements–do point to a market that is overbought. Chances are that we probably won’t see a major sell-off because we did just come off of a near bear-market move from April through October of last year, so I still think we have a potential nice move to continue in the months ahead. Also, since World War II, there have been 25 times in which the S&P 500 rose in both January and February. The market ended up for the full year 24 out of the 25 times and was flat once. The average price change for all observations was close to 20 percent. So I would say that if history repeats itself–and there’s no guarantee that it will–because we were very pleasantly surprised at the first two months of this year, we might find that we will be pleasantly surprised for the entire year.
EQ: The S&P 500 has surpassed last year’s high of 1363. As far as market corrections and recoveries go, how does this particular decline from the April high to October low of 2011 compare historically?
Stovall: Well, I call this the 19th nervous breakdown, with apologies to the Rolling Stones, because since 1945 there have been 19 corrections, which are categorized as declines of 10 percent to 20 percent. This one was among the most severe, down 19.4 percent, and beaten only by the 19.41-percent decline that we endured back in 1976 through 1978. Normally, it takes approximately four-and-a-half months for the decline to materialize, and this one took a little over half of a month more than the average. Yet, it usually only takes three-and-a-half months to get back to break-even. This time around, it took us about a month more than it usually does, but I think a lot of investors were very surprised at how quickly we bounced back. I usually find that these corrections take place over a relatively shorter period of time, so by the time investors have re-adjusted their portfolios in anticipation of deeper declines, the market is already well on its way to recovering everything it lost in the prior corrections.
EQ: How much further do you think this current rally has to run?
Stovall: Going back to WWII, the average decline for corrections was 14 percent. So in order to get back to the break-even point, the average advance was a little more than 17 percent. Once we got to break-even, the question then becomes: How long and how far do we go beyond that? Interestingly enough, and surprisingly, the market has continued to advance an average of 9.8 percent, basically adding an additional 10 percent over a three- or four-month period after getting back to break-even. If you look specifically at the corrections that were in excess of 15 percent, then you find that the range is a little narrower, going anywhere from 3 percent to 10 percent.
So if history were to repeat itself, we could see the S&P 500 climb to just above 1400 or as high as 1500 in the coming one to three-plus months before enduring another decline of 5 percent or more. So history is certainly a helpful guide–but never gospel–to what the market might do and how surprisingly resilient it could be over the next several months.
EQ: Is there a possibility that this could be a bear market rally as opposed to being a real bull market?
Stovall: There is a difference between what I call a “cyclical” bull market and a “secular” bull market. A secular bull is a long-term bull market and usually goes on to set all-time highs. A cyclical bull market is shorter term in nature and occurs within the confines of a higher-high level. So what that means is, we peaked out on Oct. 9, 2007 at 1565 on the S&P 500. Over the time until March 9, 2009, the S&P 500 fell 57 percent to 676. From there, we advanced 20 percent off that bear market low and held that 20 percent for more than six months. So my feeling was that toward the fall of 2009, there was a confirmation that we were in a new bull market. We have continued to advance off of that March 2009-level and have not experienced a 20-percent decline from the recovery high on a closing basis.
I emphasize “closing basis” because the S&P 500 did decline more than 21 percent on an intraday basis from late April 2011 through early October 2011, but if you’re going to use hard and fast rules, you go with the closing basis. So we experienced a very severe correction. What’s the difference between a decline of 19.4 percent versus 21 percent? It’s so we can categorize pullbacks, corrections, declines, mega meltdowns and put some parameters to them. Also, let’s remember that it takes a lot longer to get back to break-even after the fall. A 10-percent decline requires only an 11-percent advance to get back to break-even and a 30-percent decline requires a 43-percent advance to get back to break-even, but a 50-percent decline requires 100 percent to get back to break-even.
So we are definitely in a bull market because we have advanced more than 20 percent off of both the March 9-low or the Oct. 3-low. From the price-change perspective, there is no doubt that we are in a new bull market. The only question could be that if you believe we actually did slip into a bear market during the summer of last year, then we have yet to see that six-month time period that would make me feel better that it is not simply a false rally. But, we’ve recovered everything we lost in that correction, so really the market reset back to zero in my opinion.
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