As Sam Sees It: Are Stocks Foretelling an Economic Recovery on the Horizon?

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: Economic numbers that have come out so far this month have been largely better than expected. Do you think they have been good enough to entice investors to come back into the market?  

Stovall: I think they’re good enough to revive the saying “green shoots,” which became popular back in 2009, where we’re starting to get some economic data that’s making investors feel a little more comfortable with the U.S. economy. One area in particular is housing information because we all know housing fell off a cliff, dragging down the U.S. stock market and economy down with it. Employment data is another important area. The feeling is that if we start to see some stability in housing, and perhaps even an improvement, then that could be beneficial to the average consumer’s sense of wellbeing. So I would tend to say that the improvement in economic data is likely to go a long way into making the average person on Main Street feel better about their jobs and hopefully that will then translate into better results on Wall Street.

EQ: There is the opinion that fact the economy has displayed this much resiliency could discourage the Federal Reserve from rolling out QE3 sooner. Is this necessarily a bad thing?  

Stovall: No, I don’t think it is. First off, I agree that some people might feel a little disappointed that the Fed might be holding off on enacting the third round of quantitative easing, but that would be like feeling disappointed because a patient in intensive care does not need an additional jolt from the defibrillator. I would tend to say that it’s a good thing because the patient is improving on their own. So if the U.S. economy might be recovering on its own, and we therefore see increased stability in at least one of the three legs of this wobbly global economic stool, then investors should feel a little bit better about that.

The impact of more stimulus isn’t certain. What if the third round of quantitative easing didn’t really do much other than offer a very short-term jolt to equity prices? What if it just simply delayed the economy going back into recession? So I am much more inclined to wait things out and to not receive a third round of stimulus because we’re actually seeing the economy improve on its own.

EQ: In this week’s Sector Watch report, you quoted Mark Arbeter, S&P Capital IQ’s Chief Technical Strategist, that the S&P 500 could potentially hit the 1,600 level by the first quarter of 2013. Can you tell us more about that?  

Stovall: Mark Arbeter is a chartered technician and he pointed out to us several months ago that the market is going through a reversal pattern. He identified it as an inverse head-and-shoulders pattern, which typically indicates a reversal of trend. His initial forecast was just based on the measured move off of that pattern, which would bring the S&P 500 up to the 1400 level. Then by looking at other economic indicators, channels, moving averages and trend lines, he has come to the conclusion that we will probably see the S&P 500 work its way up to the 1500 level, and possibly higher by the early part of 2013. So from a technical perspective, we’re finding that the outlook is fairly optimistic.

Interestingly enough, history tends to agree with that technical projection. I think one of the main things that’s holding back the investor in general is the continued concern about global economic growth as well as the decelerating pace of U.S. corporate earnings growth. Frequently what we find is that prices lead fundamentals, so maybe what we’re seeing is price changes are foretelling an improvement in the global economy and in corporate earnings a year or so from now.

EQ: Earnings season for Q2 of 2012 is almost over. What have your thoughts been on Q2 results so far?

Stovall: It has been a little bit better than expected, but not as much as I thought we might see. The average differential between the anticipated earnings and the actual earnings was about 5 percentage points based on what has happened in the last five quarters. This means that if we came in with an estimate of 5 percent growth, then we historically have come in with 10 percent growth. So with the estimate that we would likely see a 1 percent decline in year-over-year operating earnings for the second quarter, the feeling was that maybe we’ll see a 4 percent gain when all is said and done. It appears, however, that we’re likely to see only a 1 percent increase for the quarter, according to S&P Capital IQ’s consensus estimates.

The biggest areas of surprise in terms of going from negative to positive would be Consumer Discretionary, which we thought we would see a 1.7 percent decline, but now it looks as if we’re likely to see a 0.7 percent increase—in a sense, coming back from the dead. The same can be said for Financials and Healthcare, which had estimates of a decline in earnings but are now likely to see a positive result in actuality. Those sectors that are likely to see even weaker than earlier anticipated estimates include Energy, which was expected to be down 8.5 percent, but now is likely to be down 12 percent. Materials was expected to be off by a little less than 12 percent, but will likely now see a 16 percent decline in earnings. So in summary, we are on pace to see a little better than expected results in the second quarter. So far, with more than 90 percent of the companies already reported, six of the 10 sectors are expected to show year-over-year improvements, therefore leaving four sectors to show year-over-year declines.