Each week, we tap the insight of Sam Stovall, Chief Investment Strategist, CFRA, for his perspective on the current market.
EQ: CFRA launched four new indices on Wednesday, structured around the seasonal rotation strategy that you’ve pioneered. Can you tell us more about the CFRA-Stovall Indices?
Stovall: A lot of investors are familiar with the old adage of “sell in May, and go away. Do not return until St. Leger’s Day.” Well, I have found that over the years, you’re better off rotating than you are retreating. In other words, you’re better off not selling, but rather, rotating into the more defensive areas of the market from May through October. Then starting in the November through April timeframe, because of capital inflows that occur early in the year, you are better off then gravitating toward the more cyclical sectors. So, splitting the year into two—getting defensive from May through October, and cyclical from November through April—has been a winning investment approach, not only for the large-cap S&P 500, but also for the equal weight S&P 500, S&P SmallCap 600, and S&P Global 1200.
So, in conjunction with S&P Dow Jones Indices, CFRA came out with custom indices on these four different strategies. The four CFRA-Stovall Seasonal Rotation Indices are:
- CFRA-Stovall Large Cap Seasonal Rotation Index (CSAMSRLC)
- CFRA-Stovall Equal Weight Seasonal Rotation Index (CSAMSREW)
- CFRA-Stovall Small Cap Seasonal Rotation Index (CSAMSRSC)
- CFRA-Stovall Global Seasonal Rotation Index (CSAMSRGL)
All of these are found on Bloomberg, and more can be read about them here.
EQ: Currently, the only way investors can implement the sector rotation strategy is by using ETFs that track the S&P sectors. Are there any plans to create ETFs that track these sector rotation indices?
Stovall: There are plans underway to create a product for investors where the actual underlying ETF does the rotation for you. Right now, investors would have to engage in their own rotation among sector indices, which would be tax-inefficient on an after-tax basis, but it could be done in tax-deferred environment.
EQ: Earnings season has officially begun. While it’s still early, some early stumbles from Goldman Sachs (GS) and IBM (IBM) seem to have stunned the market, and overshadowing some of the better performers. From a sentiment standpoint, does this contribute to the wall of worry in that a robust Q1 could be in question?
Stovall: Yes, I think it does. There are several things causing investors to question the optimism that they’ve experienced since President Trump was elected. First off, there has been a lot of pushback to his proposed changes to health care, combined with the possible tax reduction efforts. We have also seen earnings misses for some pretty large legacy companies.
But in general, I would tend to say that investors should be heartened by how well earnings have done, at least so far in this quarter. The trajectory is similar to prior quarters, meaning that when this quarter started, the estimate was for the S&P 500 to see an EPS gain of about 9.9% with seven of the 11 sectors being in positive territory. Right now, we’re looking at a 10.1% gain in this first quarter, and earnings are really just getting started.
We’re also seeing that many of the sectors, in particular Real Estate, Materials and Financials, are expected to post even better earnings than earlier anticipated. Even Consumer Discretionary and Industrials, which were expected to see year-on-year declines in earnings growth, now appear on pace for declines that could be lessened. Even though we are very early in this reporting cycle, I would tend to say that things are starting to look a little bit better for investors. Maybe they will have reasons to rejoice in the weeks ahead.
EQ: In this week’s Sector Watch, you looked at the market’s weakness in the first half of April. Geopolitical tension sparked a bit of market volatility, but you also suggested that there was likely another contributing factor to the market gyration. What were investors doing ahead of the Q1 earnings season?
Stovall: I looked at how the market typically performed in the last five trading days of a quarter, and then what happened in the first five trading days of a new quarter. Were investors either buying because they were optimistic that earnings would beat—as they have done in each of the last 20 quarters—or selling stocks because of the worry about whether earnings would come in short. What the data showed, going back to 1989, is that the final five days of each calendar quarter showed lower frequency of advance than that of the first five trading days of the new quarter. Usually investors were engaged in window dressing, selling off those shares that they were more concerned by and then buying back into the market and in shares that they had more confidence in early in the brand-new quarter.
EQ: You also looked at market momentum at the sub-industry group level, which showed that only 30% of the 148 were trading above their 10-day moving average. Why could this weakness prove to be a positive for the market?
Stovall: It’s sort of a contrary indicator. Over the past 20-plus years, on average you have about 60% of all sub-industries above their 50-day (or 10 week) moving average. Whenever you’ve had 30% or lower above their 50-day moving average—which is one standard deviation below the mean—the feeling is maybe the market is a bit oversold.
So, I crunched the numbers, going back 20-plus years, and found that in the subsequent three, six, and nine weeks, the market ended up rising more so after it has experienced a bit of weakness down to that 30% level. The improvement in returns was not only in the percent change, but also the frequency with which the market advanced. If investors were worried that the market might see additional weakness, they can take heart that, should the percentage drop to 25% or lower, then the average percent change and frequency of advance look even better. Reversion to the mean is the old adage on Wall Street, so if you’ve been down and out for too long, the chances are that investors will look upon that as an opportunity, and buy back in.
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