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: The S&P 500 has been moving lower since the start of April, and crossed 5 percent pullback threshold earlier this week. However, the rate of the decline has been slower than the historic average of other pullbacks. What does that tell us?
Stovall: In some ways, it tells us that maybe investors are not all that worried, and that they believe the nervousness associated with Europe, Asia and the U.S. might not be as severe as the general public might believe. While I don’t have the “bat phone” to Greece’s parliament–or to any other parliament around the world–what I do is try to ascertain investor opinions on these issues by looking at market action. What the market action tells me is that the possible reasons for the decline are not likely to be as pronounced as originally thought.
Since 1950, we have had 82 times in which the market fell by 5 percent or more. The median number of calendar days that it has taken us across that 5 percent threshold has been 19. Yet, it took us 42 days to cross the 5 percent threshold this time from the recovery high of 1419 on April 2, to when we finally eclipsed the pullback threshold as of the close on Monday, May 14. The interesting thing is that of those 82 price declines that fell in excess of 5 percent after the 40th day, only 18 percent became pullbacks (5-10 percent decline), 4 percent became corrections (10-20 percent decline), and none became bear markets (20 percent-plus decline).
So while we all know that history is a great guide but never gospel, and there is no guarantee that these probabilities will lead to only a pullback in prices, it does certainly make us feel better that the probabilities point to a pullback, and not a correction or even a bear market to ensue.
EQ: As we discussed in last week’s interview, economic data in the U.S. suggests slow growth for the near term. However, could the U.S. possibly be entering another recession?
Stovall: It certainly is a possibility, but S&P Economics does not believe that we will be slipping back into recession, giving only a 20-percent likelihood of that happening. They do believe, however, that we will continue to be in what is called a “half-speed recovery.” So while the U.S. economy typically grows around 4 percent in the fourth year of an economic expansion–and the fourth year of this expansion will start in June of 2012–our belief is that we’re probably at best only going to be seeing about a 2.3-percent advance. We still believe that the economic recovery is going to be weaker by historical standards and we’re still happy to call it a half-speed recovery.
That said, history does point to some disturbing trends. Every time since 1949 that the year-over-year percentage change in real GDP was 2 percent or less, we eventually found out that we were already in recession or would slip into recession within 12 months. So again, there’s not guarantee that it will work this time but what history implies is that if we are seeing a very slow growth in the economy, then chances are we will be slipping into a recession fairly soon.
EQ: Obviously, a lot of the focus is on Europe’s economic slowdown, but is the sluggish growth from the emerging markets also something to keep an eye on?
Stovall: Absolutely. I think the European crisis is the crisis du jour, whereas the Asian slowdown is a crisis around the corner. The concern is that Greece might have to leave the eurozone, and the market wants to see what kind of impact that could have, not only on the Greek economy, but also on foreign banks that hold a lot of Greek debt. But even beyond that we are seeing even softer-than-expected numbers coming out of Asia. Since Asia in general, and China in particular, is regarded as the economic engine of optimism, should China not be able to successfully engineer a soft landing–and as a result, eventually slip into a softer or even a hard landing–then that certainly is a concern that could exacerbate the worries already emanating from Europe.
EQ: S&P Capital’s Investment Policy Committee still maintains the 12-month target of 1450. Could this pullback be setting up a rally in the market?
Stovall: Our target is still 1450 for 12 months out, but a move to 1450 from the current level of around 1330 represents a 9-percent increase, which is actually equal to the historical average annual price appreciation. So coming off of what is now a pullback would imply that we wouldn’t call it a rally, but rather a normal 12-month advance. The reason why I believe we could still see that 9-percent price appreciation is because S&P analysts as well as Wall Street analysts have actually been raising their 12-month earnings projections. Even if we were to apply the current EPS expected for the S&P 500 in the first quarter of 2013, then applying the current multiple of 13.5, that gives us a number that is very close to 1450. By just factoring the expected earnings growth and maintaining the existing compressed P/E multiple would suggest that in a year’s time, the market can drift higher to that target level. So if you want to call me a “bull,” I would only suggest that you do so with a lower case “b”.