As Sam Sees It: Investors Turn Bearish Even As Fundamentals Hold Steady

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.

EQ: As you discussed last week, we're currently in a "median market" in which there doesn't seem to be any clear indication of an impending sell-off. How should investors approach the market in this case?

Stovall: The market is almost always vulnerable to a decline of 5 to 10 percent. They happen almost every year going back to World War II. So the real question is if this market is susceptible to an even deeper decline. When I look at the factors that fundamental investors look to, the answers I keep coming up with say, "No," because this is pretty much a median market. If you look to the recent 12-month "as reported" P/E and earnings yield, they are currently trading at about 15.7 and 6.3, respectively.

They're basically equal to the median since Wall Street started computing as reported earnings in 1936. So if investors are wondering whether this market expensive, I'd say not by a historical perspective. I should note that as reported earnings is another term for GAAP, or Generally Accepted Accounting Principles, which includes everything such as write downs for discontinued operations, options for executives, and so forth. It incorporates a lot of the things that don't fall into the operating earnings and that's why some people like to use GAAP earnings because it includes everything.

So even if you go back to 1988, when Wall Street started looking at operating results, both GAAP and operating earnings are trading at a more than 20-percent discount to the median over the past 24 years. Taking that a few steps further, if you look to the first quarter year-over-year increase in as reported earnings, S&P is forecasting a 9.5 percent increase. We're expecting this year-over-year percent change to decline to 9 percent in the third quarter before rising once again. What's interesting is the current level, as well as the third quarter number, are very close to the median of 9 percent going back to the late 1930s. So again, while the P/E and earnings yields are right on target with the median since 1936, the year-over-year increase in as reported earnings is very close to, and will soon be equal to, the median since the late 1930s.

Additionally, if you look at the battle between stocks and bonds, specifically the rolling 12-month total return for the S&P 500 versus the Barclays aggregate, we're pretty squarely within one standard deviation of the norm. Based on these reasons, I really would not say that we are looking at stocks from a fundamental perspective or even a comparative perspective that indicates that they are trading at extremes.

EQ: Last week's economic data reports showed pretty clear signs that growth will be slow, and the market reacted as such. Do you get a sense that investor sentiment may be shifting now?

Stovall: Sentiment is certainly shifting. S&P's chief technician Mark Arbeter, indicates that the sentiment has dropped to the bearish area, and some would look at it from a contrarian standpoint to say that we are at a bearish extreme. In particular, the CBOE Equity Only Put/Call Ratio jumped above 1.00 on an intraday basis, which is an extreme level in his opinion. Considering that we're still in a bull market, his belief is that many times a drastic pickup in bearish sentiment during an intermediate to long-term uptrend has represented a good entry point. Of course, there is no way to know exactly where that entry point is or whether this is occurring within the confines of a new bear market. However, chances are we're probably experiencing a near-term lull in the market, which could be followed by some sort of recovery. I think we'll just have to wait and see what the other economic data--both domestically and internationally--combined with the worries of the new governments will bring and how they will all weigh on equity prices.

EQ: Has the S&P 500 broken out of it's uptrend? It's pulled back to it's 50-day and 65-day moving averages. How important is it for the S&P 500 to bounce off from these levels?

Stovall: There are several ways to look at uptrends, and one way is by using moving averages. The 50-day and 65-day moving averages are good short-to-intermediate term moving averages. The 200-day seems to be the crucial one though. If you overlay the 50-day on top of the 200-day, and see that the 50-day crosses below the 200-day, that is called the "Death Cross," which usually precedes bear markets. Conversely, when the 50-day moves back above the 200-day, that is called the "Golden Cross," which makes investors feel better because it indicates that risk is back on. Right now, the S&P is below its 50-day moving average, and recently broke and closed below its 65-day moving average. However, it is still well above its 200-day moving average and its overall chart support level. So I would keep an eye on the 200-day moving average as well as the percentage decline from the recent recovery high of near 1420. Both of those would indicate whether a new bear market is around the corner.

EQ: In Europe, the previously adopted austerity measures seem to be on the verge of breaking down once again. What kind of impact do you see this ongoing situation having on the U.S. aside from knee-jerk market gyrations?

Stovall: From an economic perspective, Europe is obviously very important to global GDP growth. About 15 percent of U.S. exports go to Europe, and even more of a percentage goes from China to Europe. Most people are anticipating that Europe is or will be in recession, and that many of the nations will either post sub-1 percent growth or more likely year-over-year declines in real GDP this year. The big concern, however, is with the newly elected governments in both France and Greece and how the new leadership will be addressing the previously agreed upon austerity measures. Of the more immediate concern is whether Greece and the several billion dollars of debt coming due in the next week or so. Should the leadership find it difficult to pay off that debt, that would cause Greece to not only be in technical default, but be in actual default, which is something that the E.U. has attempted to offset and resolve over the past two years.

It's interesting because governments are reflective of their voters, and the voters appear to be engulfed in austerity fatigue. What worries me is if Germany ends up experiencing support fatigue. If that happens, voters would no longer want to bail out those countries that are not even willing to adhere to previously agreed upon austerity measures that would help resolve their debt issues. In other words, I think a lot of people in Germany are upset with the fact that this drowning victim is upset that they have to swim to the lifesaver that was just tossed to them by the German government and German voters.

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not necessarily represent the views of 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:

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