Each week, we tap the insight of Sam Stovall, Managing Director of US Equity Strategy for S&P Capital IQ, for his perspective on the current market.
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EQ: This week’s Sector Watch seemed very optimistic of the market’s prospects to trend higher. The S&P 500 has enjoyed a nice run since mid-May, and especially after finally breaking through 1900, though it seems to be taking a bit of a breather the last few sessions. Are the fundamentals supporting this recent run-up?
Stovall: There doesn’t seem to be much standing in the way for the S&P 500 to continue to work its way higher. The market seems to be ignoring those very vocal bears and stock market historians who were looking to the traditional weakness in the summertime. I think that’s causing many to feel that maybe there won’t be some of those problems as the year progresses.
In terms of the fundamentals, we’re only a couple of weeks away from the beginning of the second quarter earnings reporting period. Again, it seems as if the S&P 500 will start posting some low single-digit increases, and continued record earnings are expected to be posted in the coming months.
In general, the trend is still positive for earnings and still favorable for the stock market, but at the same time, valuations right now are dead on in terms of historic averages. The average P/E on an operating or as-reported basis and the estimated 12-month earnings for the S&P 500 on an operating basis are pretty much on the long-term averages going back over the last quarter century. So it may end up supporting the market, but I think it’s still going to be hard to propel the markets much further.
EQ: Considering that the fundamentals are in line with long-term averages, and there doesn’t seem to be obvious catalysts one way or another, is this what a “normal” market looks it?
Stovall: Well, if this is what normal feels like, then I guess we must normally feel uncertain. The market does tend to climb a wall of worry, and right now there are a lot of worries out there. They range from continued growth of earnings, to dysfunction coming out of Washington, to geopolitical tensions and so forth. So we have our fair share of those.
People may be wondering how they may put their money to work today if we’re fairly valued and the P/E ratios are equal to long-term averages. If they decide to wait for a correction in hopes of better buying opportunities, they may find that earnings come in stronger than expected and we don’t end up with a correction at all.
My feeling is that if money is burning a hole in your pocket, then engage in some dollar-cost averaging and put some money to work toward the end of each month. Sooner or later, you will end up picking up some good bargains.
EQ: Last week, you said that breadth of an uptrend is a positive for bulls. One of the weaker areas from the past months were Technology and the small-cap market. Have those areas joined in on the rally?
Stovall: Yes, they have. From June 1 through June 10, the S&P 500 was up 1.4 percent. Meanwhile, Technology was up 1.7 percent during that same time. So we’ve seen some improvement in Technology over the market.
Even more important is that the S&P Small Cap 600 is up 3.2 percent during that same time. So while this group has been lagging and a cause for concern for investors, it appears as if we’re recouping much of the loss that we had seen and it makes us feel better once again that breadth is on our side.
EQ: From a historical perspective, there seemed to be a lot to be concerned about heading into the sell in May period and the second quarter of a mid-term election year. Are the current indicators showing enough positive signs to counter that sentiment?
Stovall: I think even though we are in the vulnerable period for the S&P 500, what it means is we just don’t have a catalyst yet to push us downward. June has not been a month historically where declines of 5% or more start off. Since World War II, only 4% of declines that were 5% or more started in June. In comparison, July and August both have a rate of 10% for deeper pullbacks.
So if we think the fireworks will be delayed, then it will probably be delayed until July or August, and we will continue with the respite in June. I would tend to say that the reason why seasonals have not been working with us is simply because we haven’t had any event to trigger a sell-off. We’ve simply continued to have good economic and earnings data to help support us.
EQ: The market is increasingly being described as “complacent.” In a recent interview with CNBC, you attributed the recent stall in the market to Eric Cantor’s loss in Tuesday’s primary. Is this enough to shake investors out of their state of complacency?
Stovall: Complacency is a characteristic that can cause investors to not be on their guard and therefore cause them to react more so to what is perceived to be a game-changing event. I think most investors prior to Representative Cantor’s loss in the primaries would have said that it was a very safe seat and that, in fact, the Republicans had a good chance of gaining a plurality in the Senate while at the same time maintaining their majority in the House.
But I would tend to say that as a result of Representative Cantor’s defeat, both of those possibilities are now in question. So politics may end up throwing a curveball at the markets that they now have to contend with, and the possibility that we may continue with gridlock as it exists today.