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: After breaking through the 1700 level to close out the previous week, the S&P 500 has been gradually pulling back to this week. Did investors take the milestone achievement as a signal to start taking some profits off the table?
Stovall: What traditionally happens is once the market eclipses a century mark—and in this case, that was the 1700 level—investors experience a bout of exhaustion and tend to give up the gains that they had just made. Stocks will go through a bit of consolidation before breaking above that level once again and move meaningfully beyond that. That’s in line with our expectations. The S&P 500 will likely go through a consolidation, or noise, which is a decline of less than 5 percent, before turning around and moving into the mid-1740s to 1760s, or even a bit higher, before once again becoming more vulnerable to a meaningful decline in excess of 5 percent.
EQ: When the market bottomed in 2009, value investing was the predominant strategy since just about everything was undervalued. Given how well the market has done and where it stands now, should investors be focusing more on growth strategies?
Stovall: That’s an interesting psychological evolution that takes place within a bull and a bear market. Usually at bull market tops, people say that timing doesn’t work, mainly because along the way you have had several people come out to say that the end was here, only to find out that the market just keeps going up.
Yet, at the same time, at market bottoms, a lot of people say that buy-and-hold investing is dead. They talk about momentum being dead at the bottom of a bear market, yet you have to let your winners ride at the top of a bull market.
Back in 2009, the market obviously bottomed from a 57-percent price decline and then we started moving substantially higher from there. You can claim that the old saying, “A rising tide lifts all boats,” benefited stocks over the next several years. “Don’t confuse brains with a bull market,” is another old saying that people have been mentioning. I think now that we are beyond the fourth anniversary of the start of this bull market, and because valuations are getting close to long-term averages, investors need to do a lot more home work. They need to be a lot more selective, and they do need to be focusing on appropriate valuations.
So where is the growth? Is the company undervalued at this point based on growth expectations? You do want to be more selective on the stocks that you are beginning to accumulate now.
EQ: In this week’s Sector Watch report, you explained the STARS Swapping strategy for investors who may feel a bit uneasy with hot names that might cool off. Can you tell us more about this strategy?
Stovall: When the market is rising and earnings are still growing, valuations are still under their long-term median, and we see no recession on the horizon, investors probably want to maintain a full exposure to equities based on their time horizon, risk tolerance, and so forth.
Yet, if they’re developing an itchy trigger finger and feel that they have to do something to lock in some profits, why not sell out of those stocks that have a very high relative strength? I used a 14-week look back that basically examined the ranking of all stocks on a scale between 1 to 100 with 1 being the lowest and 100 being the highest relative strength. Stocks that have a high relative strength above 70 and also have unfavorable fundamental recommendations by S&P’s analysts in addition to our quantitative measures may be candidates to consider selling out of. You could swap them for companies with very low relative strength that have not participated in the recent move, but are considered very attractive investments by our analysts and our black box.
Potential names to consider for the STARS Swap stocks strategy. For more information, go to www.getmarketscope.com:
EQ: Does the STARS Swapping strategy counter that old adage of letting your winners ride?
Stovall: In some ways, you could say it does. However, in other ways, letting the winners that you had purchased a while ago ride could be how you do it. For those stocks that you are looking to add positions to today, you probably want to focus on the old saying of buy low and sell high. With the market having run quite nicely for a while and valuations becoming a little closer to the longer-term averages, you probably don’t want to go too far out on the P/E curve. However, on the momentum curve, maybe you do want to look for those that might not have participated so far.
On the other hand, it’s also an indication that there are a variety of strategies that have worked when adhered to over the long term.
James O'Shaughnessy wrote a book called What Works on Wall Street, where he went back to 1950 and looked at many different investing strategies. He looked at valuations, such as low price-to-book, low price-to-sales, and low P/E, as well as momentum. What he found was from a valuations perspective, you are much better off looking for the low P/E, low P/B, and low P/S. But if you were a momentum investor, you were better off focusing on those with positive momentum rather than eroding momentum. So just as there are a variety of personalities of investors, so too are there a variety of different investment strategies that have worked.