Each week, we tap the insight of Sam Stovall, Chief Investment Strategist, CFRA, for his perspective on the current market.
EQ: In the past week, the S&P 500 has fallen nearly 5%, much which coming from Wednesday’s drop. It’s been largely attributed to investor nervousness toward rising interest rates, but that isn’t the only looming headwind. There is also the IMF lowering its outlook for global economic growth, the midterm elections, and ongoing trade tension with China. Has anything changed in terms of the market landscape from your perspective?
Stovall: Yes, interest rates have been on the rise for a while—at least in terms of short-term rates—but what really has, in a sense, put a crack into the dam is the yield on the 10-year note rising so precipitously from below 3% to 3.25%. I think that took a lot of investors by surprise. It triggered attempted profit taking from the cyclical sectors as well as from the growth stocks. As it gathered steam, with the worry that the trade tensions are actually slowing global economic growth expectations, I think investors are now starting to wonder whether a recession is now a possibility in the next several months, caused not by the yield curve but by the slowdown in economic growth.
We think that the market is getting ahead of itself. Yes, we did have some nice advances in the face of challenging fundamentals, and as a result, really don’t have a lot of support underneath this market. I think that’s why share prices have dropped so much, but I don’t think that the economic growth should be called into question. So, as a result, maybe this becomes a pullback (5-10% decline), but I don’t think it becomes a new bear market.
EQ: One thing potentially working in investors’ favor is earnings season is ready to kick off. As we’ve discussed in previous interviews, expectations are for pretty high EPS growth nearly across the board for this quarter. Could strong earnings serve to smooth out some of the market turbulence like we’ve seen in previous quarters?
Stovall: Yes, in each of the last 26 quarters, the S&P 500’s actual earnings exceeded the end-of-quarter earnings, and they did so by an average of 4 percentage points. So, possibly we could be seeing earnings higher by about 25% instead of being up 21% as expected. With that said, I think investors are now questioning what further growth we could see, and what will be the catalyst for that growth.
Right now, expectations are for about a 19% gain for the fourth quarter and about a 10% advance for all of 2019. Those numbers really have not changed in quite some time. So, I think investors will have to listen closely to what management will be saying in terms of guidance, and whether those estimates will remain firm or if they have to come down.
EQ: In this week’s Sector Watch, you provided an outlook for Q3 reporting season, and mentioned currency and trade issues as potential headwinds to watch for, particularly with Consumer Discretionary and Technology companies. Do you think this will become a bigger topic covered in management guidance and earnings calls going forward?
Stovall: Yes, it will. I think what will exacerbate the question about forward guidance is how it is displayed with the S&P sector level earnings. As of the end of September, several sub-industries were removed from Consumer Discretionary and put into Communication Services. Ditto for Technology. So, some of the higher beta sub-industries remained in the Consumer Discretionary and Technology areas. Maybe we’re sort of comparing oranges to tangerines when it comes to earnings on a year-over-year basis for those two sectors.
So, I think questions will arise regarding trade and the dollar, but at the same time, I think there will be some confusion because it will not be a true year-over-year comparison for those sectors.
EQ: Attention for the midterm elections has been picking up steam as campaign trails heat up across the country. In recent years, the market has been caught off guard with some monumental surprises like Trump’s election and the Brexit vote. Is there potential for that kind of market shock event for the upcoming midterm elections?
Stovall: It could be. In the past six months, each of those months saw positive performances for the S&P 500, whereas normally, the second and third quarters have posted average declines in midterm election years. So, maybe we are getting a resetting of the dials all in one month, which possibly could’ve been seen in that six-month period.
Also, uncertainty always accompanies midterm elections because on average the party in power tends to lose 22 seats in the House of Representatives and four seats in the Senate. Expectations are that the Democrats will regain control of the House but not the Senate, but still, that is up for question.