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: Stocks enjoyed their best January since 1997. So based on the January Barometer, this bodes well for the market going forward, correct?
Stovall: Yes, it does. During any given year since World War II, whenever the S&P 500 has been up in January, it has been up for the entire year more than 85 percent of the time. So this indicates that as goes January, so goes the year. Last year it worked, but only if you included dividends. However, it doesn’t matter if you make a field goal by six inches or six yards. If it still goes over, then it’s good.
With the market rising over 4 percent in January of this year, it bodes well for the entire year. An interesting factoid, however, is that this is a presidential election year, and whenever the S&P 500 has been higher in the month of January in a presidential election year since WWII, the market has been higher for the full year 100 percent of the time. Of course, there’s no guarantee that this will work this year, but that kind of consistency can at least be encouraging.
EQ: Were there any specific catalysts or drivers for January’s rise?
Stovall: Yes, it is three-fold. First off, the U.S. economy continues to move further and further away from the double-dip recession precipice. It also seems more likely that China will be able to engineer a soft landing rather than a hard economic landing. Finally, because of the ECB’s liquidity injection in early December, it now appears as if we will not be at the mercy of a credit crunch the way we were following the collapse of Lehman Brothers in 2008.
So with a lot of macro-events looking more encouraging, and seeing price performances improve—particularly the improvement in prices for small and mid-cap stocks, as well as international stocks–investors are now of the belief that we are in much more of a risk-on environment then we were from the end of April through the beginning of October in 2011.
EQ: As you expected, there seems to be a reversal with investors shifting toward more cyclical sectors in January and away from the defensive sectors that performed so well last year. Can you talk more about that?
Stovall: Sure. Historically, the cyclical sectors tend to post the strongest results in the first quarter of each year, and the defensive sectors tend to lag. What is surprising, however, is that on average the defensive sectors tend to decline in the first quarter of a new year. Usually, I would expect a rising tide to lift all boats, but since 1990, I have found that the defensive sectors tend to post negative results on average. Actually, January 2012 has been no different from the average performance of sectors in the first quarter of each year. Materials (up 11.1 percent), Financials (up 8.0 percent), and Technology (7.6 percent) sectors were the best-performing groups for the month.
The worst-performing groups were defensive sectors like Consumer Staples, Utilities, and Telecommunications services, each declining more than 1.5 percent.
EQ: The S&P Mid-Cap 400, Small-Cap 500 and Global 1200 indices all outperformed the S&P 500 in January. Does this mean that risk appetite of investors is coming back on?
Stovall: Yes, I believe it does. It also supports the premise that we made in October that the Oct. 3-low was the low for this very severe correction that we experienced. Plus, it confirms that the market this time around is being true to history in that the cyclical sectors tend to outperform, the small and mid-cap stocks tend to outperform, and the global stocks tend to do quite well also. What’s interesting is that most investors look to the S&P 500 and see that, on a closing basis, we only experienced a severe correction. Yet, if you look at the S&P Mid Cap 400, S&P Small Cap 600, as well as the Global 1200, each of those indices definitely slipped into bear-market mode this last summer. So you really could say that the sectors, the asset classes, and the cap sizes are experiencing a traditional V-shaped recovery after having experienced a bear market.
EQ: You noted in this week’s Sector Watch report that February is one of the worst months for the market, but is usually followed by a strong performance in March. How should investors brace for this upcoming volatility?
Stovall: I think they should simply be aware of it and not react emotionally in a way that could end up hurting their portfolio’s performance. When you travel by air and you’re about to hit some turbulence, the pilot comes over the announcement and says, “Please fasten your safety belt.” He does not say, “Don your parachutes and assemble by the door.”
So just because turbulence is likely, I think it’s best to be aware of it, but by being aware you’re more likely to just ride it out. Also, historically after a decline in February, the market tends to gain what it lost in February and then some by posting a fairly healthy advance in March.
EQ: So would you suggest investors sell in February and buy back into the market in March?
Stovall: I’m not a very successful short-term trader, so I would simply say that if you wanted to do something, you could either re-balance as the market declines in February, add to your equity holdings, or just stay put and realize that volatility is around the corner. Only if you feel very confident about your short-term trading skills would I encourage you to try to capture the peak of this move, get out, and then hunt around for the trough some time in February.