Each week, we tap the insight of Sam Stovall, Chief Investment Strategist, CFRA, for his perspective on the current market.
EQ: In this week’s Sector Watch, you noted that the most recent correction that the market endured lasted more than twice as long as the average duration of a correction. However, in terms of magnitude, it was quite shallow in that the decline was only at 10.2%. What, if anything, made this particular correction so different?
Stovall: What made this correction so different was the speed with which it went down. We declined more than 10% in only 13 calendar days, which was the shortest time that it took to eclipse the minus-10% threshold since World War II. This market went down very fast, but then seemed to stabilize very quickly. So, I’m not really sure, in a sense, what caused it to drop so precipitously and then to end its decline.
But I think it took its time so that we ended up going through both a correction in price and a correction in time. Valuations had become extreme. We were trading at more than 26 times 12-month GAAP earnings, more than 19 times forward 12-month operating results, and it just seems things had gotten out of hand and were too optimistic. So, dials had to be reset, and they were in both price as well as duration.
EQ: You also reminded investors of the post-correction run-up that usually occurs after a resetting of the dials, which has historically been around 7%. But also cautioned them of the potential implications that may have on the market’s performance for the 2019. At the risk of getting ahead of ourselves, how should investors position themselves for the expectations of muted growth and perhaps higher volatility in 2019?
Stovall: Well, our Investment Policy Committee looks at earnings growth expectations, interest rate projections, and a variety of factors when making our 12-month target price for the S&P 500. Right now, it is at 3,100, which is about a mid-single digit price appreciation expected for the coming year. This obviously is below the long-term annual average, but our belief is it’s because a lot of the good news has already been built into share prices.
Also, we’re going to be seeing tougher comparisons next year because we had very strong earnings growth to date and also are expected for the remainder of the year, which is therefore going to set the bar pretty high when comparisons are made in 2019. Plus, the Fed has indicated that it plans on continuing to raise rates at a very telegraphed and measured pace, but still, the market will have to endure higher rates going forward.
So, I just believe that there are going to be more headwinds that we have to deal with and not enough new optimistic catalysts before us that could help propel share prices even further. As a result, I would say to investors that while we could end up with a nice end of year, fourth quarter pop in this midterm election year, don’t expect that angle of ascent to remain in 2019. They should look for a lower trajectory in the year ahead.
EQ: International markets are also expected to be coming out of their slumps next year. What implications could that have on US stocks?
Stovall: If investors still believe that the world is in a bull market, then they will rotate and not retreat. That means they won’t sell out of stocks altogether; they will simply gravitate to those areas that are undervalued and offer greater upside potential. International stocks have done quite poorly from a developed perspective, and many emerging markets are in bear market territory right now. So, I think investors are obviously licking their wounds in this area and, if they have not already gotten out of the international arena, are probably wondering why they still have exposure to these different areas of the market.
But I think the market does go through rotations and we do end up with reversions to the mean, which implies that we have some greater opportunities because certain areas were so overlooked for an extended period of time. For 2018, while the US should see about 22% growth in earnings, the Developed Internationals are expected to only see a 5% gain, and Emerging Markets are expected to be up less than 8%.
In 2019, however, S&P 500 earnings are expected to come in at about half of where they are for 2018, whereas Developed International should rise about 9% and the Emerging Markets should nearly double. So, it appears as if earnings growth is expected to be more favorable overseas as these economies emerge from their economic slowdowns.
EQ: On Wednesday, Dow Jones reported that the US is seeking to re-engage China on trade talks. While developments on that front are still unfolding, what type of upside potential could a cease fire on the trade war create for the market?
Stovall: I think a cease fire in that regard as it relates to Canada as well as China would be optimistic. Even though I think most investors don’t think that a trade war was something that was down the road and that the governments would end up coming to some sort of an agreement, there was still always that possibility that things could get out of hand.
As a result, the Chinese market on a year-to-date basis was down more than 15% through Tuesday. Earnings, however, are expected to be up 10% in the S&P China BMI Index but are expected to rise more than 17% in 2019. So, it looks as if China is going to be offering better earnings growth in the year ahead, and should there be a lessening in trade war tensions, then I think investors would feel more optimistic that those estimates will be met.