As Sam Sees It: A Healthy Dose of Skepticism is Good for a Bull Market

Sam Stovall |

Each week, we tap the insight of Sam Stovall, Chief Equity Strategist for S&P Capital IQ, for his perspective on the current market.

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EQ: The current bull market officially entered into its sixth year this week, it’s astounding to see some of those performance numbers coming off the bottom. But looking at the peak of 2007, we’ve seen a reshuffling of where the sectors stack up. Were you surprised that three sectors—especially Financials—are that far below their 2007 levels?

Stovall: Yes, I am a little surprised, but it’s simply a reminder that if you lose 50 percent, you need to earn 100 percent to get back to break-even.

From March 9, 2009 to March 7, 2014, Financials gained 259 percent, but is still off by 38 percent from the 2007 peak. Similarly, Telecom Services grew 68 percent but is still down 17 percent, and Utilities gained 77 percent but is still down 4 percent.

So investors need to remember that importance of understanding percentages.

EQ: Overall, the S&P 500’s price change was very similar to the EPS change, but on a sector level, there were some differences. Materials, as an example, had a price change of 177 percent but EPS levels grew by 3600 percent. What are some of the reasons of those gaps?

Stovall: Most of the big gaps between earnings growth and EPS growth really came from the cyclical sectors. Materials, especially as it relates to emerging markets, showed the biggest change in earnings but only showed market performance in price change.

However, Financials increased 366 percent in earnings versus the 259 percent in price, is better than the market’s performance on both sides. Yet, it’s still nowhere near enough to be able to account for the entire drop during the prior bear market.

Another cyclical sector that showed very strong earnings growth was Consumer Discretionary, which was up 293 percent in earnings and up 324 percent in price. Here’s another good example that we shouldn’t assume there’s a one-to-one correlation between earnings growth and price appreciation because investors are looking at valuations combined with future earnings growth expectations.

At the same time, you could look at the more defensive areas like Consumer Staples, Health Care, Telecom and Utilities. Their earnings growth were only in the double digits, which is substantially below that of the overall market. Three of these four sectors also saw price appreciation that was significantly below that of the overall market. Only Health Care came in close to the market’s advance with an increase of 171 percent versus the S&P 500’s 178 percent.

EQ: Small caps and mid caps outperformed the broader market by a wide margin, which is expected when risk is on. But considering the fact that their EPS growth rate outperformed their price increase over this time, does this suggest that these segments are fairly valued, if not undervalued?

Stovall: I agree with the first point of the question. Small caps saw a 630-percent gain in earnings growth but only a 275-percent gain in price appreciation, so some might think that this segment was shortchanged.

But when you take a look at what the earnings growth expectations are for the coming year, as well as the P/E multiples, I wouldn’t necessarily say that small caps are cheap right now. They had been doing very well from a momentum perspective, and could end up continuing to do relatively well. But if you look at the end-of-2013 estimates for small caps earnings growth, and compare the expected 17 percent with the P/E ratio of close to 27 percent, they may look pretty expensive in that regard.

The 2014 P/E ratio of 20 looks more palatable, but the only way you get there is with a 35-percent increase in earnings. Factor in that the S&P 500 itself is expected to show an 8-percent gain in earnings, it’s a little bit optimistic to think that we are going to then have a 35-percent gain in earnings for small caps in order to then make the P/E ratio a lot more palatable.

My feeling is that from a fundamental perspective, while small-cap stocks might have been shortchanged in their price appreciation from their bear-market bottom based on the earnings they have already seen, but I don’t think that we’re going to see earnings growth that’s going to be four times what we think large caps will likely be.

EQ: You ended this week’s Sector Watch report by addressing that an increasing number of investors are now wondering when this bull market will end now that we’ve just crossed a milestone. As more and more people ask that question, will that uncertainty play into itself and start affecting confidence?

Stovall: Perhaps it’s possible in the short run, but I actually think that the more this bull market is disliked from a contrarian perspective, the greater the likelihood that it will last longer than we expect.

The reason is because if people are worried that it is going to be ending soon, then chances are that they have been reducing their equity exposure. As a result, there will be money on the sidelines to potentially flow back into the equities market.

So if we don’t get a correction, the bears may acquiesce thinking they probably got out too early, and then provide additional fuel to keep the bull market alive.

Usually, bull markets die when everybody is optimistic, and as a result, there’s no money left to support or propel prices. But bull markets tend to continue when it’s still viewed skeptically by the average investor. 

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to:


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