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: The market seemed a bit surprised today when it was reported that some Fed officials had mentioned the possibility of increasing short-term interest rates. Could this Fed regime actually be more hawkish than originally expected?
Stovall: I think what the minutes indicate is that the Fed is trying to come to some sort of consensus to what they might do next in terms of short-term rates. Yes, they are all in agreement as to their wanting to get QE3 out of the way, so they will push ahead with tapering and complete it by either the end of the third quarter of this year or into the fourth quarter. Either way, our expectation is that they want QE3 over and done with by the end of the year.
The next question is whether they want to get rid of the guidance of the 6.5 percent unemployment threshold as a level which they start to consider raising short-term rates. Or, do they just take out that statement altogether and replace it with something else. It was the lack of consensus by the other members that has caused Wall Street to worry that a hike in short-term rates is likely to be sooner, rather than later.
But unless we find out that the first quarter GDP was really affected by weather and weather alone, I think investors believe that this economy remains too fragile to consider slowing it by raising the short-term interest rates anytime soon.
EQ: One of the criticism under the previous FMOC under Ben Bernanke was that there was perhaps too much information communicated to the market because of the varying individual opinions. Do you think that is going to continue?
Stovall: It’s my belief that Fed Chair Yellen is of a similar mindset where she is one who looks to gain consensus, but since I don’t know her personally, I can’t say for sure. However, I think that has been a criticism of the Fed and has certainly not fallen on deaf ears. So there could easily be some sort of change going forward that there are more measured comments made by members of the Fed.
EQ: In this week’s Sector Watch, you discussed the increase in volatility as we extend into the late stages of the current bull market. One of the factors that you identified is human behavior and investor confidence. What are the effects of an extended bull market on investor behavior?
Stovall: I measured the number of 1-percent increases and decreases on a daily basis in years one through six for all bull markets since World War II. What I found was that the first year had the greatest number of one-day increases and declines. I think that’s mainly because during the first year of a new bull market, investors are still very uncertain as to whether we are indeed in the beginning of a new bull market. As a result, they are very reticent to be caught in a bull trap. That’s why they’re more willing to sell first and ask questions later.
But as the bull market ages into mid-life, we find that the volatility on average tends to simmer down and hit the lowest in year three. As the bull market ages beyond that, we find that investors realize that the music will end sooner or later. And like a game of musical chairs, the longer the music goes on, the more the players become anxious and realize that soon the music will come to a halt. That’s why we see in years four, five, and six of bull markets that traditionally we find volatility tends to pick up the further we move into the age of a bull market.
EQ: How many bull markets have gone on to year seven?
Stovall: Since 1949, there have been 10 bull markets and three of them (1949-56, 1974-80, and 1990-2000) lasted longer than six years. The one that started in 1949 lasted eight years; the one from 1974 lasted seven years; and the one from 1990 lasted 10 years.
So there’s a real possibility that this one could last not only to year six, but even beyond. Because we haven’t seen the economy spurt ahead so quickly that the Fed would be inclined to reign in growth, our expectation is that GDP growth will be at about 3 percent for all of 2014, versus a more normal 3 to 4 percent that we typically see based on where we are in the economic cycle.
EQ: What could trigger the end of this current bull market?
Stovall: There are a variety of things. Maybe we find that earnings growth will start to fall and post declines rather than advances as we have seen in mid-to-upper single digits over the last couple of years. Maybe we find that profit margins are declining, or possibly we see that we are overwhelmed by concerns overseas—in particular a deflationary spiral that emanates from Europe or that the continued push through of the tapering of QE3 causes additional problems in the emerging markets.
There are a variety of factors that could cause some problems in this bull market, but I think the longer these are concerns, the greater the amount of time we have for the market to factor them into current share prices.
EQ: So from a historical perspective, we’re not approaching uncharted territory in terms of the duration of this bull market.
Stovall: That’s right, but of the 10 bull markets since 1949, only 60 percent of those that survived year five went on to survive year six. So, basically we’re looking now at fewer and fewer observations. So, yes, it’s been done in the past, but I think investors will continue to become nervous as they worry when the market will finally slip back into a bear market mode.
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