Each week, we tap the insight of Sam Stovall, Chief Investment Strategist, CFRA, for his perspective on the current market.
EQ: Since coming out of the Thanksgiving holiday, stocks have bounced higher in a pretty strong way. The S&P 500 is running up to the resistance level that you described last week. Is this a critical point for stocks?
Stovall: Yes, and I think it is because we set the new closing low on the Friday after Thanksgiving. On a closing basis, the S&P 500 declined 10.2% Friday versus the 9.9% low that we saw back in late-October. However, because the end of October had a lower low on an intraday basis than the intraday low on Nov. 23, I think there’s a bit of confusion here. Most technicians will say that we now need to retest the Nov. 23 low.
In the meantime, however, we’re going through a relief rally, simply triggered by the market being oversold, but now also based on the fairly favorable interpretation of the comments from the Fed Chair.
EQ: As you alluded to, Fed Chairman Jerome Powell gave a speech Wednesday at the Economic Club of New York that helped to propel stocks higher. One statement in particular indicating that he feels rates are just below neutral seemed to get the market more bullish. What do you think of this?
Stovall: Well, I think that investors have had to deal with an ever-rising wall of worry, and in my opinion, trade has been the keystone in this “arch of agita,” as I call it. Interest rates were certainly a concern—how long and how far would the Fed push rates higher? We are also facing a peak in corporate profit growth. Each of the quarters in the future are likely to post record levels of earnings, but the year-on-year change will be slowing down, and trade is a very important aspect of it all.
I think investors were listening very closely because the Fed is releasing notes in addition to Fed Chair Powell’s speech at the New York Economics Club, and I think most people were hoping that the Fed would end up at least sounding a little less hawkish about its intent going forward. Prior to the speech, I think most people believed the Fed would raise rates in December, and by as many as three times in 2019. Let the rhetoric begin, but now it appears investors are going to question how much more after the December rate will we likely see, and I would tend to guess that the consensus starts pointing to maybe only one rate hike in 2019.
EQ: In this week’s Sector Watch, you pointed out that the sell-off the market experienced in the third quarter of this year was the third worst behind 2008 and 1997. Though you did point out that there is a very good chance the selloff is near its conclusion. What would that mean for stocks in the final month of 2018 and looking into 2019?
Stovall: Well, I think it would mean we could end up with that end-of-year seasonal rally. The S&P 500 has recorded its best average performance in December, rising 1.7% on average since World War II. Also, the frequency with which the market has risen in December has been among the best. So, with the market being pounded as it had been through the end of Thanksgiving week, I think investors were really starting to worry that we would end up with no Santa Claus rally at all. Remember the old saying, if Santa should fail to call, the bear will come to Broad and Wall.
But should we get any kind of favorable comments as a result of the upcoming G20 meeting regarding negotiations between the US and China, that could end up being two out of the three things that worry investors most.
EQ: In our previous interviews, you identified those three potential bullish catalysts for the market—interest rates, trade tensions, and earnings estimates. With Fed Chair Powell’s statements today, one of those may already be materializing. The trade talks with China continue to be tense, however. If only one or two of the catalysts come to fruition, what implications could that have on your market outlook?
Stovall: Well, they all play together. Think of it as three weights on a scale, and the investors being on the other side of that scale. I think that the smallest concern, in my opinion, was the Fed raising rates because it has been done in such a measured and transparent manner. Also, the Fed funds rate continues to trade well below the year-on-year change in headline CPI. The Fed funds rate is between 2-2.25%, yet we’re looking at inflation of 2.5%. Bull markets have traditionally ended when Fed funds has been above inflation by 250 basis points. Basically, we have a long way to go, in my opinion, before the interest rate to inflation differential starts to sound any warning bells.
The second important thing, I believe, is trade because it is such an uncertainty. The reason I leave earnings last is because trade is probably one of the biggest unknowns as it relates to the earnings shortfall in 2019. So, if we come to some sort of an agreement between the US and China, I think that would end up being beneficial to corporate profits. In terms of 2019 earning growth expectations, it was for a 10% gain as of Sept. 30, yet now it is for a 7.5% gain.
Furthermore, without any kind of a trade agreement, we could see earnings growth estimates fall to anywhere from zero to 5%, which is half of what was expected just a few months ago. So, I would tend to say—in a leapfrog fashion—it’s interest rates, trade and, as a result, earnings. Those are the three factors weighing on the market today.