Each week, we tap the insight of Sam Stovall, Chief Investment Strategist, CFRA, for his perspective on the current market.
EQ: The Federal Reserve released minutes from its December meeting on Wednesday, and it would seem that the language supports the notion that the Fed may be taking a more dovish approach. What were your thoughts?
Stovall: My thought was that most people had anticipated the December minutes would read that the Fed would be on autopilot pretty much as was stated in the press conference following the December meeting. But they also realized that a lot of that had been walked back by the Fed last Friday in which they actually had urged a little more patience in terms of what would likely happen. That implied, along with the minutes from today obviously, that their stance is a bit more dovish than would’ve been interpreted from that December press conference.
So, in general, I think this definitely sounds like ancient history, but at the same time, it reminds investors that the Fed has apparently adopted a more dovish stance.
EQ: The S&P 500 has bounced 10% since hitting the Christmas Eve bottom. In this week’s Sector Watch, you wrote that the worst may be behind us, especially through the lens of valuation levels. Can you give us some perspective as to just how low valuations were at the bottom and where they are at now?
Stovall: Yes. On Dec. 24, 2018, the S&P 500’s P/E on forward 12-month earnings was 14.07, according to S&P Capital IQ estimates. That’s just a shade above 14, which is interesting because that multiple rivals the average of 13.7 that was recorded during the 10 prior pullbacks and corrections since the bull market began. My feeling is that we got awfully close to that low reading and, as a result, I think investors decided it was time to move back in rather than wait for an even lower print.
EQ: You noted that since World War II, the market has not seen successive down years with the exception of two prior bear markets. What does that potentially mean for this year from a historical perspective?
Stovall: The S&P 500 fell 6.2% in 2018, and we’ve only had three other times with which the market fell successively. Two occurred in the bear market of 2000-02, and once it occurred in the bear market of 1973-74. Interestingly enough, we only had one calendar-year decline during the bear market of 2007-09. So, unless one thinks that a bear market is around the corner—which we do not, because we don’t think a recession is on the horizon—I think that it increases the likelihood that 2019 could be a positive year.
Taking that one step further, I monitor the rolling 52-week relative strength between the S&P 500’s price and the forward 12-month earnings estimates, and this ratio fell to between one and two standard deviations below the mean since inception, and this ended up being the lowest reading since late October of 2008.
So, while it’s not a guarantee that this market has reached bottom, I think the combination of absolute P/Es, the relative indicator between prices and earnings forecasts, and the infrequency of successive down years implies a pretty good chance that 2019 will end up closing higher.
EQ: The volatility that investors and traders have seen in the market, particularly over the past month, has been compared to the price action typically seen in bear markets. Do you agree with that comparison? What implications could that have for investors?
Stovall: First off, I think volatility is a better indicator of the end of bear markets than the beginning of them. I find traditionally that actual price performances are more of a coincident indicator than a leading indicator. With that said, the S&P 500 came within a hair’s breadth of falling into a bear market, declining 19.8% on a closing basis. So, one could say that the volatility did emulate those periods in which we were in a bear market mode. When you look at mid caps or small caps, those two were indeed in bear market territory, down 23% and 26% respectively, since the Sept. 20, 2018 high.
Volatility traditionally is on the upswing during bear markets, but if I can add one more comforting factoid, that is in the years subsequent to negative years in the S&P 500, the count of days in which the market was up or down by 1% was 28% lower. Meaning, in terms of volatility, we had fewer days in which the market posted 1% moves or greater in the year after a down year.
EQ: In last week’s interview, we mentioned that the market seemed to have rotated more into the defensive sectors in 2018. However, it would seem that the cyclical groups were the ones outperforming in this early period of 2019. Does this suggest investors are shifting away from that defensive mindset, or is it still too early to tell?
Stovall: I guess it depends on your time horizon. It’s still too early to say that all of the negative performance is out of the way because I still think that there’s a possibility the market will go through a retest of the low seen a week ago. So, we could probably end up being able to buy at prices a little better than we’re seeing today. As a result, we could end up seeing a bit of a give-back to these outperforming cyclical sectors that have posted nice returns since the Dec. 24 bottom.
For all of 2019, however, our belief is that the market will end up moving higher, and as a result, we could end up seeing investors begin to gravitate away from the very defensive posturing that they took during near-bear market decline.
Also, I think that a cyclical outperformance could be occurring, which would actually be in-line with historical precedent. In the November through April period, the cyclical sectors have tended to lead the way whereas in the sell in May six-month period, the defensive sectors have taken a leadership role.
EQ: Looking at sector performances, Technology was the leadership group during the course of this bull market, but it has started to slow down quite a bit. Is it too early to determine which new group might take up that mantle going forward?
Stovall: Well, history would actually say that those sectors that ended up being worst tended to be first in the recovery. So, the worst-performing groups in this market downturn were Energy, Industrials, Materials, and Tech. So, if history were to repeat itself, and there’s no guarantee it will, these sectors could end up being the ones that bounce the furthest because they had sold off the most.
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