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: The market is currently experiencing a rotation as the appetite for risk is returning for investors. One of the ways we’re noticing that is the acceptance of more volatile stocks as evidenced by S&P’s High Beta and Low Volatility indices. What have you noticed there?
Stovall: We know how well the Low Volatility group did in the first quarter. Including dividends, it was up 13.2 percent versus 9.2 percent for High Beta index. Yet, for the first 17 days of May, the High Beta group was up 9 percent while the Low Volatility group was up only 1.3 percent.
So there was a definite rotation into the higher beta stocks, and I think that was primarily because investors thought the Low Volatility group had gotten ahead of itself. Also, valuations were getting a bit elevated for the more defensive areas, while the higher beta, more cyclical stocks were representing much more of an attractive investment opportunity.
EQ: In this week’s Sector Watch, you mentioned the possibility of the market being in a new secular bull market. What do investors need to see in order to confirm that?
Stovall: The answer to that is fairly elusive. The difference is that a secular bull market is long term, and a cyclical bull market is shorter term. I found that secular bull markets are those that establish all-time highs and stay at those levels for more than six months. Back in the early 1970s, the Dow broke and stayed above 1,000 for only a short period of time before breaking back below that threshold. So obviously, the secular bull market was delayed until 1982. The most recent break above prior highs occurred in 2007, but then it topped out in October. So that new all-time high did not last very long before we slipped into a new bear market.
This time around, we got back to break-even in late March, so we’re just going to have to wait and see how long we stay above the prior high before declaring that a new secular bull market has started.
Other ways investors can decide if we’re in a secular bull market is if we see the cyclical areas of the market doing well. Sectors such as Consumer Discretionary, Financials, Industrials, Materials, and also the Transportation index are showing strength moving forward. So there are a lot of factors that one can look at, but the real definition is more on a semantic basis than a financial basis.
EQ: So the possibility of a new bull market being in play has attracted more investors into the higher beta and cyclical sectors.
Stovall: That’s correct. I think investors are basically saying they don’t want to be buying into a market that could just as easily go down as easily as it has recently gone up. They don’t want to be stuck in a whipsaw kind of environment. However, I found that from 1982 to 2000—which was the most recent secular bull market—we actually had quite a number of pullbacks, corrections, and cyclical bear markets that took place within that longer-term secular bull. So it doesn’t necessarily mean that being in a secular or long-term bull market that we don’t have pretty substantial digestions of gains along the way.
EQ: You also discussed different ways that investor can implement this rotation into higher beta stocks. One method is with the S&P 500 High Beta ETF (SPHB), and the other is through purchasing individual stocks. How would you recommend investors to select names to consider?
Stovall: I did a fairly simple screen using the S&P’s MarketScope Advisor platform. The first thing I looked for were companies that had positive investment recommendations by our equity analysts. So from a qualitative perspective, these stocks are ranked buy or strong buy. Then I wanted to overlay that with our quantitative system called Fair Value, which is based on a variety of computer-driven metrics and tells us whether a stock looks attractive or not. So from that perspective, we are also looking for those that are ranked buy or strong buy. Since I really only wanted a limited number of stocks, I kept raising the bar on what the beta is, and came up with a minimum beta of 1.9.
I came up with 12 stocks, 11 of which had a beta of 2 or higher.
Four of the companies came from Consumer Discretionary:
- Ford Motor Co. (F)
- Goodyear Tire & Rubber Co. (GT)
- Harman International Industries, Inc. (HAR)
- PVH Corp. (PVH)
One came from Energy:
- Nabors Industries Ltd. (NBR)
Three came from Financials:
- The Hartford Financial Services Group, Inc. (HIG)
- MetLife, Inc. (MET)
- Prudential Financial, Inc. (PRU)
Two from Industrials:
- Joy Global, Inc. (JOY)
- Textron Inc. (TXT)
Finally, two from Materials:
- Alcoa Inc. (AA)
- Eastman Chemical Co. (EMN)
EQ: Last week you also mentioned the possibility that instead of Sell in May, we could get a Swoon in June or experience some softness in during the summer. With that in mind, do you have any suggestions on how investors should weight their portfolio allocation in the near to intermediate term?
Stovall: From the perspective of implementing the strategies I discussed above while also considering what investors might hear about later on that could pose as shorter-term and riskier in nature, my response would be to first, determine your equity/fixed-income/real estate allocation. You can do that by going online and taking a variety of tests based on your goals, time horizon, risk tolerance, and other factors.
For example, you could use the old adage of 110 minus your age as an appropriate equity exposure metric. Once you figure out how much you can have allocated toward equities, figure out a small amount of that could be regarded as the aggressive growth portion of your equity exposure. In a sense, it’s your play money. This would be the money you could expose to potential higher returns, knowing full well that it could experience increased risk as well. My feeling is this would be where you allocate to high beta or other kinds of investments. This is the kind of money that you could afford to lose because it’s only a small portion of your overall portfolio—rather than being the bulk of it—and where you making changes would not could drastically affect your long-term goals.
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