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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Stovall: I don’t necessarily see it as a dark cloud for the markets in general, mainly because nobody can comprehend that Russia would be so stupid to do something that’s going to adversely affect global economic growth when they themselves are teetering on the edge of recession all the time.
So while it does end up creating diplomatic tensions and help to sell newspapers and cause people to tune onto the evening news, I think the very quick recovery after the sub-1 percent decline that the three U.S. markets experienced on the day Russian troops assembled on the Ukraine border gives an indication on how unfathomable a global recession as a result of this is likely to occur.
EQ: In this week’s Sector Watch report, you discussed the bull market heading into its fifth year. Typically, bull markets add an additional 26 percent if they make it through that far, which would propel this current run into the top three all-time best bull markets. How likely do you see this happening?
Stovall: While the average of a 26-percent advance for the sixth year of bull markets since 1947 has been very encouraging, I don’t give a lot of weight to the likelihood that we will see a similar advance this year. Yes, we could end up with a positive year for 2014, but because the economy continues to creep along at a relatively weak pace and earnings are expected to come in at an advance of around 8 percent, I think we’re likely to see a mid-to-high single digit price advance in 2014, and maybe even a similar amount for the entire sixth year of this bull market.
A 26-percent advance would push us to 2340 on the S&P 500, which is a number that just sounds so alien to me at this point. I think it’ll be a good year, but it probably won’t be that kind of a great year.
EQ: In terms of fundamentals supporting the bull market, it seems the numbers and valuation would suggest that prices are fair at the moment. Would the market need some sort of spark to achieve a 26-percent gain?
Stovall: Right now, if you look at the trailing 12-month operating P/E, you’ll see that we’re trading at only a 2 percent discount to the median over the last 25 years. So I would tend to say that rather than get an 8-percent increase in earnings, we would need to see something in the teens to get that kind of growth.
Instead of the 3-percent increase in real GDP that is anticipated for 2014, I think we would need to see a surge in economic growth expectations to allow investors to push P/E multiples higher than the current 15.5 to 16 that we’re looking at for projected operating results. I also think that in general, investors just need to feel very confident that a recession is not around the corner and that maybe Congress will be able to pass a meaningful change to the tax code in 2015, so that kind of a carrot for investors—GDP growth, earnings increases, as well as changes to tax policy—we would need to see much more optimistic expectations take place I think for us to be able to see double-digit gains, let alone a 26-percent advance.
EQ: To the point of investors feeling confident that there isn’t a recession around the corner, if the market does not manage to extend into a sixth year, what is the likelihood that we’ll be looking at a hard landing?
Stovall: If bull markets typically end with recession, then I would say that this bull market ends in a bear market that it probably will be because the expectations of a recession around the corner. Right now, the market—ourselves included—are not looking for a pickup in inflation, and as a result, we don’t expect to see the yield on the 10-year note rise dramatically, nor do we expect to see the Fed funds rate rise dramatically.
If, however, we have underestimated inflationary expectations, and we find that short-term rates rise, which would end up flattening the yield curve or maybe even throwing it into an inverted yield curve scenario, which would mean that short-term rates are higher than long-term rates, then I would say that could end up foretelling the possibility of recession.
If we were to go into a bear market because of recession, I think an awful lot would have to change that is not being expected currently.
If, however, an external shock such as a natural disaster or a further deepening in the military tensions not only in the Crimea but also over the islands in Asia contested by Japan and China—in a sense, unanticipated events, they too could end up throwing us into turmoil. But again, those are not situations that we’re expecting or contemplating.
EQ: If the market continues to chug along the next few years with low-to-mid single-digit gains, is that still counted as part of this current bull market’s run?
Stovall: There’s no uniformly embraced definition of bull markets and bear markets, but most people you talk to will say that a bull market is a gain of 20 percent off the prior bear-market low and that a new bear market is when we’ve experienced a 20 percent decline off of the prior bull-market peak.
There are some strategists out there that say a bear market is also a sideways move for a specific period of time, but we don’t regard that. If you’re not losing money, then you can’t really call it a bear market? So if we ended up with low-to-mid single-digit advances on an annual basis over the next several years, we would still be in a bull market to me. Although, I would call it more of a lazy bull market than a roaring bull market.
