As Sam Sees It: June Headlines Could Drive More Volatility

Sam Stovall |

Sam Stovall Chief Equity Strategist for S&P Capital IQWhile the S&P 500 has enjoyed a nice bounce over the past two weeks, investors will still need to brace for some near-term volatility in the market. The latter half of June could bring more uncertainty as several key developments, both in the U.S. and internationally, come to a head.

In this week's interview with Sam Stovall, Chief Equity Strategist for S&P Capital IQ, we discussed which sectors are gaining attention from investors, and the risks of playing macro headlines in the current market environment.

EQ: Since bouncing off low on June 4, the S&P 500 has held up pretty well for the most part, but is the upside potential still limited by the current economic headwinds?

Stovall: The market has done relatively well to date for the month of June, and even including that final capitulation day on June 1, is up a little more than 1 percent. All 10 sectors are in positive territory, though not by a large amount. In addition, even though the S&P 500 has bounced back a little bit, the leadership is coming from some of the defensive areas, in particular Telecom and Utilities. That's interesting because it implies that while investors are willing to go back into stocks, they're only willing to go back in a very defensive and safe manor. Some of the weaker-performing groups are Consumer Discretionary, which had done very well leading up to this market decline, as well as Financials, because investors are still very worried about what could be happening in Europe with the bank bailouts and the cascading effect there could be for the U.S. market.

So headlines still dominate, and there are a variety of headlines that investors have been focusing on, ranging from geopolitical, to economic, to fundamental, as well as anecdotal. By anecdotal, I mean the fact that the yield on the 10-year note recently was at a record low, and gold prices and oil prices have been declining. All of those negative factors were causing investors to wonder what was going on and think maybe they were better off selling everything and putting the cash under their mattresses so they can sleep better at night.

EQ: In this week's Sector Watch report, you pointed to two indicators that could be helpful in determining the market's sentiment. Can you tell us about them?

Stovall: There were two indicators I looked at recently that usually are pretty good indications of when the market has hit a bottom. However, right now they're in disagreement with one another. The first indicator is a rolling 10-week (50 day) average correlation of the sub-industries in the S&P 500 as compared with the S&P 500 itself. A correlation of 1.00 is exactly equal to that of the market, and the average for all 130-plus sub-industries since 1995 has been about 0.63. However, recently we spiked to 0.86. Whenever correlations rise dramatically, it's an indication that investors are very nervous and are basically saying, "I want to sell everything. It doesn't matter if the demand for the products and services might be different for that of the overall market. I just don't like the direction that stocks are headed."

As a result, correlations tend to gravitate toward 1.00 during periods of panic, and that's what we're seeing. Although, usually it serves as a contrary indicator because when everybody is nervous, who's left to sell?

EQ: What was the second indicator that you looked at and what did it tell you?

Stovall: On the flip side, I also looked at the trailing 50-day average intraday volatility, which is the percent change between high and low in a particular day. It implies that if you have very high volatility, then we are approaching the end of this downward move. Unfortunately, the volatility measure is still very low, and is actually below the average going back over more than 40 years. So looking at price volatility of the S&P 500 itself, we are no where near an extreme. If the implication is that there's more downside movement to go, well then, to borrow an old song title, "We ain't seen nothing yet."

But, obviously there's no guarantee that this is what will happen. If you look to correlations of sub-industries, however, the measurement does indicate that we are, or at least we were, getting close to a panic level. This implies that in the near term we were due for some sort of a countertrend rally, which we are now getting.

EQ: In terms of a catalyst for the upside, investors may be speculating on additional stimulus from the Federal Reserve and other central banks. Is this a risky play for investors?

Stovall: It's a good point, because investors really should be buying stocks based on the growth potential and current valuation for those individual issues. If you think growth potential for a particular company is better than what's currently being reflected in price, then you buy the stock. When investors are looking more at the macro rather than the micro, then it seems that they could be more easily whipsawed by emotions. When you get rumors that run rampant, speculation that is shared, government data that is frequently revised, and so forth, it adds to volatility because one day's news could be refuted by tomorrow's news.

So just as job seekers are hoping for the government to bail them out, if investors are waiting for the government to bail them out--such as the Fed with more stimulus, or the Treasury or from even Congress--then they're playing a risky game because Congress has shown so far to have only been successful at inactivity rather than activity. Also, we wonder if the Fed has run out of silver bullets. So really, investors should be focusing more on individual companies, growth potential for those companies, and whether they are appropriately valued by the market.

EQ: In that sense, would you categorize this as a stock picker's market?

Stovall: I think that's a good way of describing it. It's not necessarily a stock market but a market of stocks at this point. These are phrases that are frequently thrown about to try to describe and characterize particular market environments. Right now, however, investors are trying to decide whether risk is on or off. If risk is on, then investors are more willing to embrace high beta and high cyclical sectors. However, risk right now seems to be off as investors are very worried about the next headline to come around the corner.

They're worried about the upcoming Greek election, the G-20 Summit, as well as the U.S. Supreme Court's ruling on the mandated healthcare coverage in the Obamacare act. So there's a lot of headline news out there that is causing investors to be very nervous, and we might find that that news gets worked into stocks even before an announcement is made.

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. 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: http://www.equities.com/disclaimer

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