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: May has not been kind to the bulls, falling over 7 percent month-to-date. Is this shaping up to be one of the worst months the market has ever seen?
Stovall: It has been a pretty bad month, certainly for the S&P 500, which declined 7.3 percent through May 18 and was down 8.7 percent since the market peaked in early April. I wanted to see how the month-to-date decline of more than 7 percent compared with history, and found that it was worse than 96 percent for all full-month results for the S&P 500 since World War II. Next, I wondered if this type of rapid decline typically happens in pullbacks (5-10 percent), corrections (10-20 percent), or if they are reserved more for bear markets (20-plus percent). Much to my encouragement, if you will, 73 percent of the remaining 4 percent of severe declines since WWII occurred when the S&P 500 was already in bear market mode, meaning that the market had already fallen over 20 percent. This implies that we usually get a very sharp sell-off when people are already very fearful and panicky because we have already dipped into a bear-market mode. This time around, however, we had a fairly accelerated decline before we have even crossed the 10- or even 20-percent threshold.
EQ: As you’ve noted before, usually the worst performers during a down market tend to be the strongest performers during its recovery . What are some possible targets that investors may want to look at now?
Stovall: For investors that want to buy low and sell high, there are areas where they can do some nibbling right now, but only if they have a high risk appetite because this market could fall even further. So I would suggest investors be aware of that and make sure they’re not investing with next month’s rent money. But if you did want to take advantage of some of these bargain-basement prices, our recommendation would be to look at those groups that have been beaten up the most, because traditionally, those that were worst soon become first. The reason is because if you have companies, industries and sectors that were priced to go out of business, but did not, then they are the ones that investors feel have the greatest profit potential during a recovery.
From the beginning of April when the market peaked, through May 18 at its trough, these sectors were among the worst performers:
- Financials (13.7 percent decline)
- Materials (13.1 percent decline)
- Information Technology (12.1 percent decline)
- Energy (11.6 percent decline)
Surprisingly, there were two sectors that actually rose for this period; Utilities were up 0.2 percent and Telecom was up 4.7 percent.
In terms of sub-industry performances, there were 10 that had slipped into bear market mode, declining by 20 percent or more. Among those include:
- Trucking (23.7 percent decline)
- Household Appliances (23.8 percent decline)
- Investment Banking and Brokerage (24.8 percent decline)
- Steel (25.1 percent decline)
- Other Diversified Financial Services (28.0 percent decline)
EQ: Facebook (FB) has been the biggest news in the U.S. markets this week after falling over 15 percent from its IPO price. What were your thoughts on its failure to live up to the pre-IPO hype?
Stovall: There were a lot of things that got in the way of the actual issuing of the shares. It was interesting, with all the hype ahead of it, because it’s history in the making. Since I like to look at history, obviously, if you can live through it, it makes the history more interesting and more relevant. I had people ask me if we were experiencing another dot-com-like bubble when dealing with any of these social networking companies. In some ways, you could say investors were pleased that we did not see people piling into a stock and driving it substantially higher even though, when it was issued, was trading at close to 90x projected earnings. This is compared with 14x for the S&P 500 and the range of 16x to 26x for many of the other Internet-based companies that are trading today.
On Wednesday, May 23, Standard & Poor’s came out with a 2-STARS investment recommendation, which is a “sell” rating for the stock. Our stock appreciation rating system gives 5-STARS for a “strong buy” ranking and 1-STAR for a “strong sell” ranking. So this was ranked a sell. We have a 12-month price target of $30 on the shares. Our concern is of valuation, and also the acknowledgement that the Internet space in general–particularly the social media segment–is that technologies and taste are always changing, which poses challenges to incumbent companies and offerings. So we’re basically telling investors that you might not get your money’s worth over the coming year, so you’re probably better off looking somewhere else.
EQ: Is Europe the determining factor right now of whether the market will bounce back or push lower? Should it be?
Stovall: The week after Facebook came out was the week in which U.S. economic data was relatively strong. Yet, investors were still quite unnerved by Europe. So the focus is almost exclusively on Europe, the reason being the lack of clarity and total uncertainty as to what’s going on. The belief is that Greece is possibly playing chicken in order to improve their bargaining position to reduce the onerous austerity plan that had already been agreed to, as well as encourage more growth. Also, because of the recent election in France, the current president is also promoting growth with austerity. The Germans, however, seem to be the ones constantly footing the bill for whatever programs that come out, and are steadfastly sticking to the previously made agreements in which most countries would be embracing a fairly strict austerity plan.
So until we get more clarity as to the interest in Germany to bend a little bit–perhaps on the addition of growth options within the framework of an austerity plan, combined with the possibility of a euro bond being issued to replace a lot of these sovereign debts–until we get a little more clarity on that kind of flexibility, I think Europe will continue to put pressure on equity prices.