As Sam Sees It: Anticipating When the Music Stops

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.

For more from S&P Capital IQ, be sure to visit www.getmarketscope.com.

EQ: Over the past week, the S&P 500 has fallen nearly 3 percent. Is this just a little bit of early turbulence or should the market brace for a deeper decline from here?

Stovall: It’s not just investors trying to take some profits from the outsized gains seen in 2013, but also the result of investors becoming increasingly worried about a currency crisis in the emerging markets, as well as potential slowdown in global economic growth.

So we really have to take a wait-and-see approach. S&P Capital IQ has not changed our target or allocation recommendations. However, we do believe that prices lead fundamentals and if we don’t get the rally that we expect to come in the next few days, then we could be slipping into that 10-percent correction that so many people have been predicting.

EQ: You discussed in this week’s Sector Watch that the recent sell-off wasn’t just limited to U.S. stocks. Stocks of pretty much all types around the globe participated in the drop. Are investors beginning to look to other asset classes as the expectation of a pullback/correction increases?

Stovall: Yes. Initially, we really didn’t see much action in the 10-year note or gold, so my feeling was that maybe this was a decline that would soon run its course. However, as we’re now seeing the yield on the 10-year note be pushed down to 2.7 percent and gold prices pushed above $1260, it indicates to me that people are in search of a safe haven and that maybe this decline has legs.

EQ: The market is starting to feel like a game of slap hands, where the expectation of a pullback is causing increasingly forceful jerks. Is this trading environment what we should expect going forward until we do get that pullback?

Stovall: I think it’s a traditional kind of reaction to any kind of a pullback. Another analogy could be that investors are like hyperactive children playing musical chairs, always trying to out-anticipate each other as to when the music will stop. So in a jerky fashion, they try to sit down even as the music continues to play.

Then when support levels are eventually broken, we find that a greater number of people tried to exit at the same time, further exacerbating the sell-off.

EQ: We mentioned in recent interviews that a meaningful pullback would present potentially attractive buying opportunities for investors with capital on the sidelines. Do you have any suggestions for a strategy to determine entry points or establishing a position in a stock that has fallen in price?

Stovall: My belief is that it usually is good to start adding to positions at 5-percent decline thresholds. That would place us around 1755 on the S&P 500. A 10-percent decline would bring us down to 1663, and a 15-percent decline would bring us down to 1570.

I have found that many more times than not, investors are better off buying than they are bailing, and allocating money to be put to work at these 5-percent thresholds, in the long run, ends up being a very smart investment strategy.

EQ: From a technical perspective, Mark Arbeter, S&P Capital IQ’s Chief Technician, identified the 1768 to 1775 as a key level that needs to hold if the current bullish trend is to continue. We’re in that level right now. Is that a bearish sign?

Stovall: Yes, we are in a point where our belief is that we will probably rally and retest the original breakout zone of 1810 to 1815.

If, however, we don’t break above that level or don’t even rally at all from the current 1770 area, our belief is that we could be seeing a move down to the 1690 level first on the S&P 500, followed by a rally, and then a deeper drop below 1690.

His belief is that this would put us in the middle of what he calls an A-B-C correction, which is part of a downward wave cycle that could last into the third quarter of this year. The wave A of the A-B-C correction would bring the S&P 500 down to 1690, and we would see the wave B would be a rally off of that. Then the wave C would undercut the 1690 level, and possibly bring us down to the low 1600s.

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. 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: http://www.equities.com/disclaimer

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