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’re still pretty early into Q1 reporting season, but by the looks of it, results may be even weaker than were expected going into it. At this current rate, the S&P 500 may end up posting a negative for the first time since the third quarter of 2012. Do you anticipate that estimates for Q1 may fall even further?
Stovall: My guess is that the estimate of a 1.2-percent decline will probably be the low point for the quarter. Historically, what we find is that the estimated number gets improved upon by 2 to 3 percent when the full quarter has been reported. If we are now expected to be down 1.2 percent, my guess is that we end up seeing earnings come in at maybe 2 to 3 percent for this first quarter, and by the skin of our teeth, end up avoiding a decline for this quarter.
EQ: In our last interview, you discussed the possibility of corporate management using the harsh winter and weak Q1 as a possible excuse to guide expectations lower. It could serve almost as a dumping ground. Does that seem to be the case so far?
Stovall: Yes, so far it does. Usually, the fourth quarter of a bad year ends up being the dumping ground quarter. However, since we’re starting on a weak note and we have a very good excuse—meaning the bad weather in the first quarter—companies are pretty much writing down what they can to assist them in showing even better performances in the remainder of the year.
EQ: In that case, should we be expecting some nice surprises in the following three quarters?
Stovall: That certainly is a possibility. Right now, S&P Capital IQ is forecasting earnings growth of basically between 8 and 11 percent for the remainder of the year, with the full year being up 7.0 percent. So it’s definitely a back-end loaded year and we think that we’ll actually start seeing some pretty good results begin to show in the second quarter.
Also, the revenue picture is expected to be relatively healthy, up about 3.8 percent for the first half of the year, and up 4.4 percent for the second half. So revenues might actually look a little better than earnings.
EQ: With such bearish sentiment toward Q1, it’s hard to say that investors are not expecting some price weakness and buying opportunities. Could that predominant bearishness have awakened the bulls to provide a support level on dips?
Stovall: I think we still get the correction because as I’ve said in past, corrections might be delayed but they will never be repealed. So it’s just a matter of time, in my opinion, before we get a decline by 10 percent or more. We have gone 30 months without a decline in excess of 10 percent, and the average since World War II is 18 months.
It’s going to happen one of these days, and the second quarter of the mid-term election year remains the most vulnerable quarter. Could it happen in the third quarter? Sure, but I still think that with every quarter that goes on, it increases the likelihood of a correction as well as a bear market.
The six times since World War II that the market took longer than 30 months to slip into a decline of 10 percent or more, four of those six eventually became new bear markets rather than just corrections (or declines of 10 to 20 percent).
EQ: When comparing bull markets that did or did not make it past the 18-month mark, it seems that the longer-running bulls had considerably higher and longer upsides, with pretty much the same downside once they did slip into decline. Does the magnitude and duration of the increase have an effect on the eventual decline?
Stovall: Yes, I think the longer that we go without resetting the dials, the more elevated the valuations become, and also the more stretched investor optimism becomes. So I think the longer we go without a correction, the deeper it might end up going.
One reason, however, I feel as if we will not slip into a new bear market is because of the yield curve, which is the spread between the 10-year bond and the three-month Treasury bill. Right now, we are more than one standard deviation above the mean over the past 50 years, and seven out of eight bear markets actually were preceded by flat-to-inverted yield curves. So I would say that chances are we’re probably going to avoid a bear market, but most likely get a deep correction.