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: Recent data from the housing market shows the area is making noticeable progress toward recovery. Existing sales dipped slightly month-over-month in December, but is still up 12.8 percent from the year prior. Housing starts posted even more encouraging numbers for the month. Does this help to alleviate some of the concerns that investors may have for the health of the economy?
Stovall: Yes, I think it does. The housing starts data was very strong, selling a one-month increase of 12 percent and a year-over-year increase of 37 percent. I think investors were very pleased by that release. You could say, however, that they were displeased by the existing home sales data that showed a decline. However, if you look at the details of the report, you see that it’s mainly because of limited inventory. Obviously, if you have enough people out there that are willing to buy, but there’s not enough supply out there then that’s why the existing home numbers have actually declined.
In general, this housing data is encouraging for investors because a housing crisis is what caused the economy and market to go into a tailspin five years ago and we’re finally emerging from it. Also, it will probably add to the trajectory of economic growth in the quarters ahead.
EQ: In this week’s Sector Watch, you took a closer look at the correlation between housing starts and the S&P 500. What did that tell you?
Stovall: First off, it told me that just on a month-to-month basis there was only a small correlation between housing starts and stock price performances. In fact, going back to 1959, the correlation is a minus 0.03. However, if you look at extremes—a very high year-over-year increase or decrease—in housing starts, this could be much more enlightening. What I found was over the past 50 some odd years, if the year-over-year increase in housing starts exceeded 25 percent, that was a positive indicator and the S&P 500 rose an average 9.3 percent in the subsequent 12-month period. In addition, it recorded increases in two-thirds of all observations. Of course, there’s no guarantee that this kind of performance will happen again, but just looking at history and seeing the magnitude and frequency of advance, I think it has to be at least a bit encouraging.
EQ: When looking at the momentum of the S&P 500 and its 10 sectors, it seems that cyclicals—with a few exceptions, are looking pretty bullish at the moment. Is the market entering a risk-on stretch?
Stovall: Yes, actually the market has been in a risk-on stretch since the middle of November 2012 when we finally bottomed from the most recent pullback (decline of 5 to 10 percent). We got to break-even in the early part of January, breaking above the 1465 level that we saw in mid-September and now are daily establishing recovery highs.
So what I like to do is look at absolute price performances and whether they’re trading above their short, intermediate, and longer-term and moving averages. I also like to see what the relative strength of particular sectors are versus the market and how well that is doing when compared to moving averages of 4, 13, 26, and 40 weeks. What I’m finding is while a majority of the sectors within the S&P 500 are showing absolute strength—meaning their index levels are above their own moving averages—it is primarily the cyclical sectors that are outperforming the market itself. So in particular, Consumer Discretionary, Industrials, and Materials are holding up very well. Financials are also doing relatively well, and the only defensive group that is outperforming the market right now is Health Care, with Consumer Staples, Telecom Services, and Utilities being laggards.
EQ: The House of Representatives agreed to extend the debt ceiling until May with an overwhelming vote, and the bill is largely expected to pass the Senate. Is this a positive indication that Congress may finally be willing to play nice with each other?
Stovall: On the surface that’s what it appears to be, but when you realize that the stated goal by one party is to make the other party look bad, you have to dig a little bit deeper to find the true motive behind it. What I think is happening is the House of Representatives, which is controlled by the Republicans, is basically trying to put the spotlight on the Democrats and their inability to come to an agreement on things in the Senate, in particular passing a budget. Knowing that since the Republicans have a hard time coming to an agreement on cost cutting, and knowing that the Democrats themselves have not been able to pass a budget for the past four years, by delaying the debt ceiling to May 19, they are simply using this as an opportunity to show the populace that it’s not just that the Republicans who are having a hard time keeping their members in line, but rather that there is a lot of dysfunction on both sides.