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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EQ: We discussed recently that investors shouldn’t be afraid of a major cool off in 2014 because of how well 2013 had been for the market. That said, we can at least expect some volatility, right?
Stovall: Yes, I think so. As I have written recently, historically, good years tend to follow great years. In those periods in which the S&P 500 gained 20 percent or more in one year, the following year the market advanced an average of 10 percent versus its more normal 8.5 percent or so. The frequency of advance improved in that second year as compared with all years since World War II.
But the one thing that is sort of missing from this equation, or from the thought that it’s going to be a good year without worries is that of volatility.
Next year is a mid-term election year, which is also regarded as the four-year cycle low. We have had declines of 5 percent or more in each of the mid-term election years since World War II except 1954 and 1958 with the average decline being 20 percent.
Also, when we look to volatility this year, 2013 is the third lowest volatile year since 2000. The average number of times that we had an increase or a decrease in daily price swings of 1 percent or more was 80 times per year. So on average, 80 times a year, we had one-day advances or declines of 1 percent or more. So far this year, we’ve had 37. That’s less than half.
If we were to get back to a more normal number, we would have to see double the volatility next year that we saw this year. So my belief is that while 2014 could be a good year and not a great year, history says that it will also likely be an exciting year.
EQ: Do you anticipate the Fed’s tapering to have much of an effect on the market over the next few months?
Stovall: I don’t really think so because now that it’s already started, I guess the only question that people might have is by how much they will be tapering in future months, and what kind of an impact are we seeing this tapering having on mortgage rates. Will it be adversely slowing the recovering in housing, which we regard as one of the propellants for economic growth in 2014? So people are going to be monitoring it like they’re monitoring somebody’s pulse, but I don’t think it’s going to be the topic du jour everyday as it has been over the last several months.
EQ: If we do get a meaningful decline, when do you think the market is more susceptible to corrections or a deeper move downward?
Stovall: Using history as a guide—because obviously it’s never gospel—the worst quarter of the mid-term election year has traditionally been the second quarter. That’s true not only in the average price change, which is a decline of more than 2.5 percent, but also in the frequency of a price change is more apt to be down than it is to be up. That works not only for the S&P 500 but also for the Russell 2000, going back to 1978. Both the second quarter and the third quarter have been negative on average, but only with the second quarter showing a frequency of advance of only 25 percent. So in other words, 75 percent of the time the markets fell in the second quarter of a mid-term election year.
If we were to see a repeat of history, it would say to watch out for the beginning of the sell in May period.
EQ: It does seem that if 2014 plays out as history suggests, the sector rotation strategy would make a lot of sense, correct?
Stovall: Yes, it would. The sector rotation strategy says that you’re in the market from November through April, but instead of selling in May, you really rotate in May. The idea is to move from the market to the more defensive areas such as Consumer Staples and Health Care, rather than going into cash entirely. But just as in 2013, where we found that we were better off sticking with stocks altogether rather than going into cash, we may find that we’re better off going into cash rather than sticking with stocks in 2014.
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