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: The S&P 500 fell through the 1,200 level on Monday, and a large part of that drop could be attributed to the lack of confidence the market had in the Super Committee. Now that it’s widely accepted that it has failed, and the automatic $1.2 trillion in cuts is to be enacted, could we be facing the potential of another severe correction?
Stovall: I don’t think so, because very few people, in my opinion, expected the Super Committee to come to an agreement. As a result, we have the $1.2 trillion in automatic cuts that will kick in on Jan. 1, 2013. Technically, we have between now and 2013 to come to some sort of an agreement that is $1.2 trillion or larger. My belief is that the market is declining currently because we’re going through a digestion phase of the sharp advance in October as well as investors remaining very nervous. I call this a “crisis of confidence in our elected officials,” that is not just found here in the U.S. but in Europe as well.
EQ: Speaking of Europe, there seems to be a lot in play right now that’s affecting the perception of investors. They’re overlooking the recent economic numbers, which have been mostly more positive. Do you think we’re likelier now to retest or even breakthrough the Oct. 3 low of 1099 on the S&P 500 because of this lack of confidence?
Stovall: The lack of confidence is the catalyst to this retest, but our belief is that the 1099 low will probably hold because the valuations on a trailing basis were so low that we were actually trading at a 20-percent discount to the median P/E dating back to 1936. So valuations, in my opinion, look very attractive.
From a technical consideration, we have broken below the neckline on a head-and-shoulders pattern earlier this summer and the move down to 1099 is in accordance with that overall pattern. Plus, we saw consumer sentiment at the lowest level–meaning the most bearish level–since March 2009. So our belief is that the 1099 level will hold as a result of the very attractive long-term valuations, combined with the price decline associated with the technical pattern, and the very, very weak investor sentiment numbers.
EQ: One of the most stagnant areas of the economy has been the housing industry. It has arguably been so bad that many investors have given up hope on its recovery any time in the near future. Is that a fair assessment based on its performance over the last two years?
Stovall: Certainly, the homebuilding industry has been in a bear market since 2006. The Federal Reserve and the U.S. Treasury have done their best to try to re-stimulate this area of the economy with excessively low interest rates, but nothing really seems to be awakening it. We think we will need to see a gradual improvement in the employment picture before the housing market can take a real turn, but that might be a tough thing to conjure up because we still believe that the unemployment rate will average above 9 percent for all of 2012. So, only if we are pleasantly surprised do we think that there could be a sharp turnaround in housing. That said, our belief is that investors are opportunists and are beginning to look at the homebuilders to see whether they could represent a good buying opportunity going forward.
EQ: S&P Capital IQ has a fundamental neutral outlook for homebuilders, but what are some opportunities, if any, that investors may want to look at in the coming year?
Stovall: Basically, we can only look higher for the coming year. When you’re already sitting on the bottom of the ocean, you can only look upward. That where the housing situation and the homebuilding stocks are right now. Yet we think we could be seeing a very gradual improvement in the payrolls picture. We cover 10 stocks in the S&P 1500 Homebuilding sub-industry index, and there are four that have favorable investment outlooks. Plus, we have been witnessing a gradual improvement in the sub-industry’s long-term relative strength.
Homebuilder Stocks to Watch
- Lennar Corp. (LEN) — Four Star (Buy) rating
- NVR, Inc. (NVR) — Four Star (Buy) rating
- Pulte Group (PHM) — Four Star (Buy) rating
- Toll Brothers (TOL) — Five Star (Strong Buy) rating
Toll Brothers is our favorite in the category. Also, I should note that from Oct. 3 through Nov. 18, the S&P Composite 1500 was up 11.3 percent, while homebuilding was the seventh best performing group, up close to 31 percent.