As Sam Sees It: Are Prices Now Dictating Fundamentals in the Stock 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.

EQ: The market is within striking distance of the 52-week low, which was also the bottom of the August correction. There’s no shortage of volatility triggers in the market right now. How important is it for us to hold that 1867 level?

Stovall: I’m not so sure that it’s important to hold the 1867 level because my feeling was that a 12.4% correction after having gone nearly 47 months between declines of 10% or more made me feel as if we got off easy. I would have felt more comfortable with a 15% or higher decline. So maybe that’s indeed what we’re going to get—a number that ends up dropping into the lower 1,800 area. So 1867 I think that’s a number the market will be looking at, but I also believe that it will be breached.

EQ: On a technical level, we’re still in that decline because we recaptured the peak of when that decline started.

Stovall: Correct. The S&P 500 is still in a correction mode, meaning its decline between 10%-20%. The correction started on May 21, when the S&P 500 recorded a closing high around 2,131. So we would have to get back above that May 21 closing high to say that we are out of this correction.

EQ: Earnings season is upon us once again. We’re looking at the likelihood of an earnings recession and the first full-year EPS decline since 2009. How bad is this quarter looking like right now?

Stovall: Right now, the quarter is looking pretty bad. Expectations are for a decline 6.1% for the fourth quarter, which is deeper than the original estimate of a 5.4% decline. This would also be the second consecutive quarter in which the S&P 500 posted an earnings shortfall. Some people would say it’s actually the third quarter in a row. By our count, S&P 500 showed a 0.1% gain in earnings in the second quarter, but I’m not going to quibble. We’ve certainly had three quarters of challenging earnings results, and right now it’s looking like only three of the 10 sectors in the S&P 500 are expected to post earnings increases. They are Consumer Discretionary, Health Care, and Telecommunication Services. Everybody else is supposed to be in the red, dragged down predominately by Energy.

EQ: Energy is having a really hard time right now, but as you said, it isn’t the only one dealing with a crunch now too. Even the three sectors expected to show EPS growth have seen the rate come down from previous quarters. Is this softness across the board a result of some general macro themes, or is it due to a number of industry specific trends?

Stovall: You’re bringing up a very interesting point because there’s an old saying that prices lead fundamentals. But now I’m wondering if prices are actually influencing fundamentals. Yes, 2015 is expected to show more than a 1% decline for the entire year, and at the beginning of 2016 the full-year estimates were for a 7.4% increase. Now, we’re looking for only a 6.7% increase, or a decline of 9.5% from the original estimates and is similar to the 7.5% that we’ve seen in prices.

So it leaves me to wonder whether this truly is a reduction in earnings because of Energy is expected to post a 22% decline for 2016 versus its earlier estimates of an 11% decline, or is it because analysts are just slashing their estimates in response to the prices having declined so much without the fundamental backdrop having materially changed.

Granted, China is going through some upheavals, but our GDP growth estimates remain unchanged despite having China in our equation. Unemployment estimates remain positive, where it could come down to about a 4.6% level. Even though we did see a flat wage improvement in December, we’re still looking for wages to increase by more than 3% by the end of the year. So there really hasn’t even been any cracks forming in the foundation for us to be worried about. It really simply is the worry about prices that is bringing down the fundamentals, possibly undeservedly.

EQ: You did point out that earnings estimates have been eroding. The hope was that Q4 could be a troughing quarter with a recovery expected to occur in 2016. Is that in the cards, or should investors expected continued slowing from here?

Stovall: We are looking for a semi-V-shaped recovery for 2016. The first quarter is expected to be flat, but at least positively so—meaning it’s 0.0 but it shows up in Excel in a black color rather than a red color. The second quarter is expected to be a gain of 3.3%, third quarter to be up 8.4%, and fourth quarter to be up 15.4%, again because of the improvement we see for the Energy picture. So it is interesting that we will be going through four quarters of either flat to negative earnings, starting with the second quarter of 2015 through the first quarter of 2016, but then we expect to see an acceleration of earnings growth, driven primarily because of the reduction in the drag with Energy.

EQ: In 2015, we saw the estimate numbers continue to get ratcheted down throughout the year. What are somethings that we should keep an eye on when listening to corporate to see whether or not that will be the case again this year?

Stovall: We had a very sharp strengthening in the value of the dollar in which it increased by double digits. We think that we’re going to see less than a 4% increase in 2016. Something that companies cannot control is the strengthening in the value of our currency, but we could be listening to what their hedging efforts have been and whether that’s something that they can do to their benefit.

Second, I think trying to get a better feel for weakness coming out of Europe, emerging markets, and China. Is the US the best house on a bad block or the only house on a devastated block? If it seems that the US is really the only economy that is holding up, it could be a problem because none of the economies are truly decoupled. So I would tend to say to not only react to the S&P 500’s decline and use that as a reason to reduce earnings estimates, but rather listen to company management and see whether earnings expectations are truly warranted.

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