Each week, we tap the insight of Sam Stovall, chief investment strategist for Standard & Poor’s Equity Research, for his perspective on the current market.
EQ: September is historically one of the worst performing and most volatile months in the stock market. As we enter the last week of the month, does that statement ring true this time around?
Stovall: Yes it does, but certainly less so than it did earlier in the month. With the S&P at 1194 for Sept. 27, that puts us down 2 percent for the month. Yet, if we remember back to when the S&P 500 was at 1135 only a week or so ago, that would’ve indicated a 7 percent price decline. Either way, the S&P is off for the month, which is the traditional performance for September whether you go back to 1990, 1970, 1945, or 1929. In addition, the S&P 500 historically posted its worst monthly performance in September.
EQ: The market is increasingly at risk of entering a bear market. If we are heading in that direction, what can investors expect in terms of how far the market can potentially fall?
Stovall: That’s the question on investors’ mind right now. Are we simply going through a counter-trend rally and resume a downward move in the S&P 500 as we head into October? Or, is the “risk on” trade back and headed to new recovery highs? Our belief is that it’s still wise to remain fairly cautious at this point because our economic growth projections are still quite anemic and we’re starting to see weakening economic growth globally. So, at best we’re going to be eking out a gain of only about 1.6 percent for all of 2011 and 1.9% for 2012. Growth is likely to be fairly weak. There’s an old rule of thumb that says if you have two successive quarters of year-over-year GDP growth of 2 percent or lower, then historically we’ve found that we’re either already in recession or would slip into recession within 12 months.
Of course, past performance is no guarantee of future results, so you could use it as a guide but it is never gospel. If we did head into recession, and history were to repeat itself, the market top that occurred on April 29th would then imply that we would slip back into recession some time in the fourth quarter of this year, and more precisely in November. The average price declines for the S&P 500 associated with recessions is 30 percent going back to 1948. Therefore the implied target would be 955 on the S&P 500, representing a 30 percent decline off of the recovery high of 1363.
Taking that one step further, the average 18 percent decline in earnings that accompany recessions, combined with the average low P/E ratio of 12 during these market declines, would imply a target price of 985 for the S&P 500. Obviously, these numbers are not necessarily meant to scare investors but to let them know that you have to respect the impact that a recession has had on stock-market performances and could still have if we slipped into recession once again.
EQ: What is the typical duration of these bear markets?
Stovall: On average since World War II, bear markets have lasted 14 months and have declined an average of 33 percent. This is for all bear markets and not just those associated with recessions. The interesting thing is that we don’t actually slip into bear-market mode–which is the 20 percent decline threshold–until after nine months into the 14-month decline. This is typically when a downturn is confirmed as a bear market and not just a bad correction. Nine months is exactly what happened in the prior bear market. It took us until July 2008 before we realized that the market peak back in October 2007 was the peak just before the bear market occurred.
EQ: For investors tired of the whiplash and rollercoaster ride of the current stock market, where can they look to so they can maybe sleep a little easier at night?
Stovall: When investors are looking to put money to work in the stock market during uncertain times, my recommendation is to focus on three things: dividend yield, beta, and quality. There are 387 companies in the S&P 500 that pay a dividend and on average these companies have a lower beta than the non-dividend paying stocks. If you pay a dividend, traditionally your price volatility is less than that of the non-payers. At the same time, the consistency with which the average dividend-paying company increased their earnings and dividends in each of the last 10 years was substantially higher for dividend-paying companies than for nondividend-paying companies.
My recommendation is to look for the investment opportunities that offer:
- High Quality Rank: Companies with an S&P ranking of A- or better, meaning an above-average consistency of raising earnings and dividends.
- Above-Average Dividend Yield: Companies that offer a dividend yield in excess of that of the S&P 500.
- Favorable S&P STARS and Fair Value: Companies with positive investment rankings both on S&P’s Qualitative STARS technique and Quantitative Fair Value technique.
In a sense, investors are looking to the past for quality ranks; looking to the present for dividend yield; and looking to the future with STARS and Fair Value. This allows them to still be in the stock market and benefit from upward moves of the market, but also be cushioned from declining periods in the market. Investors should also note that dividend payers declined by one-half the amount that nondividend payers fell on a year-to-date basis through Sept. 23.
EQ: Energy and Information Technology have been two sectors with surprisingly low betas, relatively speaking. What are some reasons you’ve noticed that can help explain that?
Stovall: If you asked people which sectors have the lowest beta, most would correctly answer defensive groups like Consumer Staples, Healthcare, and Utilities. Telecom also has a fairly low beta because of their very high dividend yield. Actually, they have the highest dividend yield of all 10 sectors in the S&P 500 at about 5.5 percent. Yet, Energy is sort of like the fifth Beatle that nobody tends to remember. Energy stocks are relatively low in terms of volatility but they’re not among the three lowest, so that’s why people might forget them.
If a sector moves in lockstep with the S&P 500, its beta is 1.0. Any sector below 1.0 is typically less volatile versus the market. Energy’s beta over the last five years was 0.95, meaning it was 5 percent less volatile than the S&P 500. Going back to WWII, Energy was the fourth-best performing sector during bear markets and has outperformed the S&P 500, 82 percent of the time. The reason is because Energy is dominated by very large, internationally integrated oil companies that benefit from both high and low energy prices. Not only do they drill for the oil and own the oil fields, but they also sell the oil through their marketing and retail arms with the real determinant being refined product margins.
For Information Technology, most people would think this sector as the perceived poster child for volatility, and rightfully so. Over the last 15 years, Information Technology has had the greatest number of weekly declines of 2 percent or more with 210 occurrences as compared to 133 times for the S&P 500. Yet, over the last 5 years, Technology was the least volatile of the cyclical sectors. Financials was the highest at 1.50, or being 50 percent more volatile than the S&P 500. Materials and Industrials were second and third at about 25 percent more volatile than the S&P. Consumer Discretionary was 12 percent more volatile, but Information Technology at 8 percent was actually surprisingly low as compared with the other cyclical sectors. A lot of that has to do with the fact that technology has already taken its beating from its over-extended levels during the Tech Bubble. It took its beating in the first half of the first decade of this new millennium and is now trading on more realistic valuation measures.
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