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: Last week, the Federal Reserve announced, along with the ECB and several other central banks, a coordinated currency swap strategy to help shore up Europe’s banks. What were your thoughts on this announcement and the impact it’s had on the market so far?
Stovall: The Federal Reserve, as well as the ECB, basically agreed that things were getting out of hand and that the market needed some sort of statement of assurance from the central bankers that they would do something to try to stem the tide. The yields on the 10-year notes of Spain and Italy had eclipsed 7 percent, which seems to be that line in the sand above which countries eventually need a bailout. So the Fed and the ECB said that they would use their coordinated currency swap to ensure liquidity to the European banks, should they need it. Obviously, that helped investors feel more confident about the situation in Europe, and show that at least the leaders are working to resolve the issue.
However, I also believe that it’s a solution to the symptom, and not necessarily a solution to the underlying problem, which is the massive level of debt that is owned by so many of these sovereign entities in Europe.
EQ: Do you think this will have any direct impact on the U.S. economy?
Stovall: I think, maybe it’s more indirect. If these countries don’t have to pay as high a yield or higher interest rates to borrow money, then that means they’re less likely to slip into recession. As a result, they’ll be able to continue to purchase U.S. exports because the austerity measures would be less severe, and that, in turn, would not drag the U.S. into recession.
EQ: Standard & Poor’s sovereign ratings issued a notice late Monday on possible downgrades of 15 euro nations, which could also affect the European Financial Stability Facility [EFSF] as well. Are you surprised that the market has held up so well after the announcement?
Stovall: First off, as a reminder, I work for S&P Capital IQ, which operates independently of S&P Ratings.
When I saw the after-the-close commentary that these countries were put on credit watch with negative implications, I obviously paid attention to what the futures were doing. As a result, I was pleasantly surprised that the markets basically took it in stride, possibly indicating that this has been something that has been bantered about by bond and equity traders for quite some time and it was something that was anticipated, and certainly not a shock out of the blue. Also, I would tend to say that even though we have had a few bits of negative news, the markets have held up fairly well.
EQ: Last week, U.S. economic numbers mostly came in better than expected, highlighted by the big drop in unemployment. However, the drop was attributed more to a lower participation rate. Is this a positive or negative in terms of jump starting the economy going forward?
Stovall: It shows just how many layers there are to these kinds of data. First off, you really should not be reacting to data that comes out the first time, because it’s going to end up being revised anyway. I remember seeing a New Yorker cartoon where the cartoon newscaster said, “Because of revised economic data, it has been decided that the Yankees, and not the Dodgers, have won the 1981 World Series.” So you have to take government with a grain of salt, knowing that it can and probably will be adjusted down the road.
Also, what’s interesting is that yes, we did have a lower participation rate, and it was blamed on employees who were disgruntled, and therefore left the workforce because they said they’ve given up trying to find a job. Yet, what’s also interesting is that the U6, the broadest measure of unemployment that also incorporates under employment as well as disgruntled workers, went down. If these people were truly disgruntled, then that figure should have risen. I believe that the participation rate was lower possibly because people left the workforce for other reasons rather than being dissatisfied or disgruntled.
EQ: Given that volatility is still at pretty high levels, do you have any suggestions or recommendations on a good way for investors to balance their portfolios or to stay nimble?
Stovall: I think because of the volatility, it’s been a perfect example of how an emotional investor can wreak havoc on their own portfolio. They could possibly be buying just at the point when the market is likely to decline and then selling it at the point in which the market is just about ready to turn around. So, either come up with a rules-based investment approach that will eliminate emotions from the equation, or try to learn how to buy, hold and then close your eyes.
One suggestion is that when share prices decline, rather than bailing out, you should rebalance. Move some of the money from the fixed-income investments that probably have done well as equity prices have declined. You could take some of those profits and then realign them to the equity side. Or, if you decided that volatility is not your best friend, you might want to consider a relatively new index put out by Standard & Poor’s called the S&P Low Volatility Index. There is an ETF that mimics that as well.
The PowerShares S&P 500 Low Volatility (SPLV) consists of the 100 least volatile stocks in the S&P 500, and it is evaluated on a quarterly basis. It is currently priced at about $25 a share and S&P rates the ETF Market Weight. It also offers a dividend yield that is in excess of the S&P High Yield Aristocrats–so a little more than 3.5 percent.
What’s also interesting is how well this index has done during what I call, The Lost Decade, from 1999 to 11/30/11. While the S&P 500 was down 15 percent in price, it was up only 6 percent if you include all of the dividends. Yet the S&P 500 Low Volatility Index’s total return gained 154 percent. So by focusing on companies within the S&P 500 that pay a nice dividend but also have the lowest volatility, then at least over the last 12 years, they have been able to outperform the S&P in a very challenging marketplace environment. Of course, past performance is no guarantee of future results.