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: In this week’s Sector Watch, you took a close look at 1994 as a point of comparison for if and when the Fed starts tightening its monetary policy. How does the current landscape compare to 1993, just prior to the rate hikes?
Stovall: Well, the reason that I looked at 1994 was because the Fed raised interest rates six times during that year, and a seventh time for good measure in early 1995. I wanted to get an idea as to how the equity markets and the other asset classes performed in that period of rising rates. It was also very interesting to see how different the world was then versus how it is today when looking at stock market levels and commodity levels, as well as economic data points. In particular, back then the yield on the 10-year note was at 6.25 percent, versus the 2.2 percent level that we’re looking at today.
Unemployment back then was at 6.6 percent, whereas we’re at 7.6 percent nowadays. Gold, surprisingly, was at $380 per ounce, versus today’s $1,380 per ounce. Oil was at $15 per barrel instead of the $93 per barrel today. So I guess it’s not surprising to see that the S&P 500 was trading at only 482 back in 1994 versus the more than 1600 level that we have today.
EQ: Seven rate hikes in the span of 12 months seems pretty aggressive. How did the market respond to those moves?
Stovall: The first question was whether or not we got thrown into a bear market in 1994. The answer is no, we didn’t even come close. What we found was that the S&P 500 itself, at some point in the year from the latter part of January through the mid to late part of April, declined almost 8 percent. But for the full year, we were actually up 1.3 percent if you include dividends. But if you looked exclusively at price performance, we were only down 1.5 percent. Considering such a big change in interest rates—which went from 3 percent up to 6 percent on the Fed funds rate—I think the S&P 500 held up fairly well.
EQ: Looking at the performance of the market during this time, there doesn’t seem like there were many places investors could hide. However, the overall decline wasn’t as bad. Does this help to calm the nerves of investors currently watching the Fed?
Stovall: I think it does. What I tried to do in my article called “1994 Revisited”, found on our MarketScope Advisor platform, was I started out with the total returns of various asset classes. As I mentioned, the S&P 500 was up 1.3 percent on a total return basis for all of 1994, but other areas were up even more so. The MSCI-EAFE index was up 8.1 percent. The S&P GSCI commodity index was up 5.3 percent, and the NAREIT Equity-Only Index was up 3.2 percent. Of course the mid and small-cap U.S. stocks fell 3.5 to more than 4.5 percent respectively, and the emerging markets fell by more than 7 percent. The bonds actually held up a little bit better than I thought. The Barclay’s Aggregate was off 3.5 percent for the year, and the Barclay’s Long Treasury was down 7.6 percent. So while 1994 was the worst year on record for the Barclay’s Aggregate, it was second for the Long Treasury index because 2009 was even worse than 1994.
In terms of sector performances, what I found was that for the full year, things were not as bad as people had anticipated. Four of the 10 sectors ended up in positive returns for the full year. Of course, during the concentrated period of the end of January through the end of June, some sectors and sub-industries did take it on the chin. We’ve found that in that five-month period, all 10 sectors declined in price, with Utilities, Industrials and Consumer Discretionary being hit the hardest, while the market itself fell less than 8 percent. These sectors fell anywhere from 9.6 percent up to 18 percent. So by the end of the year things had come back a little bit.
Instead of 85 percent of the sub industries being down by the end of June 1994, only about 55 percent of them were still underwater for the full year. So depending upon how focused you got in terms of companies or industries, you could have done quite poorly in 1994, but the higher level you go—meaning at the sector level or the S&P 500 itself—the declines were quite muted.
EQ: After the initial shock of the rate hikes, it seemed like stocks recovered pretty well in 1994. If and when the Fed starts to taper off of the QE program, do you think the market’s reaction will resemble what it saw 20 years ago or something a bit more different?
Stovall: It should be a little bit different, because what’s happening now is that this bull market is going through a metamorphosis from being a liquidity-driven rally to being a fundamentally-driven one. Also, the bull market is still likely to remain intact, it just doesn’t need the training wheels or the push that this market needed over the past couple of years. In many ways, you can equate it to a doctor taking a patient off the intravenous; the implication is that they’re healthy enough on their own to sustain their own recovery.
Right now, I think investors are a little bit skeptical that maybe this economic growth is not strong enough to stand on its own, but once we start getting additional economic data points that show that this economy is able to recover on its own, the market itself will start to breathe a sigh of relief, and push us back toward all-time highs.
EQ: If and when the Fed does initiate a tapering of the bond buying program, it does remove some level of uncertainty from the market. Does that give investors sitting on the sidelines a good enough reason to get back into the market?
Stovall: It could be, because investors who have wanted to get back into equities are waiting for the volatility to die down a little bit before they do commit their capital. So in a sense, we don’t see it resulting in a slowing of economic growth but rather in just removing the need for additional stimulus. Then I think that this market will be able to maintain this longer-term bullish trend.