As Sam Sees It: How Investors Can Deal With Market Vulnerability

Sam Stovall |

Each week, we tap the insight of Sam Stovall, Chief Equity Strategist for S&P Capital IQ, for his perspective on the current market.

For more from S&P Capital IQ, be sure to visit www.getmarketscope.com.

EQ: GDP for the first quarter came out drastically lower than expectations, but the market seemed to recover pretty quickly after an initial dip. Was this a case where the market essentially wrote off the first quarter sluggishness?

Stovall: I think that’s the case. Even though the actual number was about one-tenth of what expectations were. Most on Wall Street thought we would see about a 1.1-percent increase in first-quarter GDP, but we ended with 0.1 percent.

Most people are just sort of brushing it off as a backward-looking indicator that was adversely affected by a very noisy first quarter, buffeted by a lot of bad weather readings.

EQ: The end of April marks the beginning of the sell in May period. However, this year’s six-month stretch has the added effect of a mid-term election year. How does the S&P 500 and the sector rotation strategy hold up during these observations?

Stovall: Mid-term election years are usually an amplification of the traditionally weak sell in May period, and that adage has been around for a while. Since World War II, the S&P 500 gained about 7 percent from November through April, but only 1 percent from May through October.

If you overlay the mid-term election years, then things become even more challenging. Since WWII, May through October of mid-term election years have posted an average decline of 1.6 percent, rather than the more traditional gain of 1.3 percent for the S&P 500 during all years.

So investors may be wondering what to do. Do they go to cash this time? Well, historically, you’re actually better off sticking with stocks, but gravitating toward the more defensive Health Care and Consumer Staples sectors, even in the mid-term election years.

Since 1990, the S&P Consumer Staples and Health Care sectors have increased an average of 5.6 percent with dividends re-invested versus the 2.8 percent for the S&P 500. In mid-term election years, we’ve also seen a pretty strong advance 4.6 percent for these defensive sectors versus a decline of 0.8 percent for the S&P 500.

Lastly, if you feel you need to go somewhere other than stocks, then history says you might want to consider looking at the Barclays Aggregate Index because in both timeframes (all years or just mid-term election years) the average increase has been between 4.5 to 4.8 percent, respectively.

EQ: So bonds proved to be an appealing asset class during this time based on historical observations. How would investors play this for the short-term given that bonds may be a bad long-term strategy right now?

Stovall: From a bond perspective, there is the iShares Core Total US Bond Market ETF (AGG) , which represents the Barclays Aggregate. So if history were to repeat itself—and there’s no guarantee that it will—we could end up with a nice return in this May through October period as opposed to a decline for the S&P 500.

However, if you wanted to stick with the defensive stock sectors, you can still look to Consumer Staples Select Sector SPDR (XLP) and Health Care Select Sector SPDR (XLV) . So either way, you do have both bond and sector ETFs that you can employ during this vulnerable six-month period.

EQ: Another group you looked at were the low volatility stocks. The S&P 500 Low Volatility Index (SPLV) suffered the most dramatic underperformance in mid-term election years. Why is this area so affected by this period?

Stovall: That’s a good question. Going back to 1991, a period consistent for the Barclays Aggregate and the S&P Consumer Staples and Health Care indices, the Low-Volatility Index did relatively well during all years. It gained a total return of 4.4 percent versus 2.8 percent for the S&P 500. However, for mid-term election years, when the S&P 500 was down 0.8 percent, the low-volatility index didn’t average much better with a gain of only 0.3 percent.

I think the financial crisis of 2008 possibly had a lot to do with this underperformance because Financials had a relatively low volatility up until that point. So you possibly had those kinds of stocks in the index at the time.

While I don’t have the exact listing of the companies in the index at that time, my assumption is that come the third quarter of 2008—and maybe even during 2000 to 2002, in which we also had a near 50-percent decline in stock prices—we may find that we had some previously low-volatility companies that got dragged down in the vacuum of declining market prices that adversely affected its long-term average.

EQ: Would that suggest that the SPLV may perform better than what the historical numbers suggest?

Stovall: It may, but I wouldn’t make that kind of projection. I would tend to say, however, that if its underperformance was due to the one bad period Financials endured, then perhaps we could guesstimate that this time around things would be a little different, and the index holds up a little better than it has in the past.

But let me add one reminder. Since 1991, while we’re dealing with 24 years’ worth of data, we’re only looking at six mid-term election years. So that smaller number of observations has an impact on how well or poorly an index might do.

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to: http://www.equities.com/disclaimer

Companies

Symbol Name Price Change % Volume
CZYB CCB Bankshares Inc 9.40 0.00 0.00 0

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