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: Over the past two weeks, we’ve witnessed considerable volatility in the market. What’s causing these bigger swings than we’ve been used to?
Stovall: I think the bigger swings really are due to where we are in the summer. Let’s face it, these declines really have occurred when a lot of people are on vacation, not just here in the U.S. but around the globe as well. The volume has been relatively low. Combine that with some of the ongoing concerns like China, and as we all know, even though China is the engine of economic optimism, it’s also surrounded by a lot of smoke and mirrors. So it’s very hard to decide exactly what kind of an economic slowdown there might be over there and what kind of an impact it could have on their economy as well as our own economy.
EQ: September has a reputation as the worst month for stocks, and Tuesday certainly was a strong reminder. Historically, how has the market performed in September?
Stovall: Quite poorly. September is the worst month of the year. Going back to World War II, all 12 months on average posted an increase of a shade below 1%, whereas September posted an average decrease of a bit below 1%. In addition, the frequency of a decline is greater in September than in any other month, meaning more times than not the market falls in September while with other months more times than not the market rises.
EQ: In this week’s Sector Watch report, you discussed why this particular September could be a particularly bearish period for investors. What are some red flags that we’re dealing with?
Stovall: Going back to WWII, there have been 11 times where the market fell 5% or more in August. Of those 11 times, the market continued to decline 73% of the time, with the average for all periods being a decline of close to 4%. Basically, it’s just a study in momentum in that if prices head lower in one month, it tends to follow suit in the following month.
Red flags that we’re dealing with continue to be concerns of when the Fed will be raising interest rates, what corporate earnings will look like in the third quarter (expectations now are for a greater than 4% decline), and lastly, how everything will shakeout in China.
EQ: It’s widely known that we had a prolonged bull run between corrections, much longer than the historical average. How could that come back to bite us now?
Stovall: It could come back to bite us because the longer we go without resetting the dials, the greater the effort required to reset those dials. When the S&P 500 fell into correction mode and closed at 1867 on Tuesday, Aug. 25, the S&P 500 was off 12.4%. Up to that point, we had gone 44 months without a decline of 10% or more, which was the third longest since WWII.
Looking at those times in which we went 30 months or longer, the median decline was 19.9%. I used median because the mean would have implied that we would have to fall into a new bear market. Since we are of the mindset that a correction is what we’re going to get this time around, I still think that we probably have to do a little more penance before the decline is fully over.
EQ: As a result of that prolonged period without a correction and considering the historical implications, does it increase the likelihood of us falling into a bear market?
Stovall: A bear market is certainly a potential. I think, however, because inflation remains so low and interest rates still are fairly low by historical standards, we are not going to be seeing inverted yield curves. Plus, with employment and housing data remaining very strong, I don’t really see us falling into a bear market. Obviously, if the pressure is coming from outside of the U.S., then looking at housing starts, employment, and the yield curve won’t really do much to ease investors’ minds that a new bear market is not around the corner.
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