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: Despite all the fears and concerns the market had to deal with over the past two weeks, the S&P 500 managed to extend its streak without a correction. What does this tell us?
Stovall: I think it tells us we still have an awful lot of investors who are in a buy-on-the-dips mentality and were very happy that the S&P 500 fell by more than 5%, and therefore made it more attractive to add to their positions. I don’t think anybody should fool themselves, however, into thinking that a correction will not be coming.
If there’s a guarantee on Wall Street, it is that while corrections might be delayed; they will never be repealed. So stay tuned because I think we’ll be given another opportunity to see how far down the market goes when it undergoes its retesting process.
EQ: For the most part, the market seems to be much calmer compared to where it was just a week ago. How do we know if and when the recent dip is behind us?
Stovall: I don’t think we can say that it’s behind us yet, but I think what made investors as scared as they were was the speed at which the market declined, coupled with the what-if mentality that investors seemed to embrace. What if Ebola ends up becoming the Spanish influenza of the 21st century and wreaks havoc on the airline, restaurant, and entertainment industries in general? What if we find that ISIS takes over Iraq and becomes another terrorist state that is even all the more so aggressive toward the United States?
What if Europe does indeed fall into a triple-dip recession that is also caught in a deflationary spiral? How would that affect China’s economic growth slowdown? Will it slow the U.S.’s economic recovery?
So these were factors that contributed to the decline that have not been fully resolved. I do think investors are feeling less anxious about those items, but we still need to go through some sort of retesting process, and only if that retest is successful—meaning we do not establish an even lower low—will investors feel fairly confident that the worst is behind us.
EQ: As the Fed has withdrawn its bond-buying program this year, interest rates have not reacted the way most people expected. Given what we’ve seen the last several weeks, are deflation concerns on your radar?
Stovall: I don’t think that deflation is that big of a concern here in the U.S. The most recent inflationary numbers, the CPI numbers, came out positive on a month-over-month and year-over-year basis, reversing the negative reading we saw in September. As for the low 10-year bond yields, while it does reflect investor concern about the speed with which the U.S. economy recovers in the year ahead, I think a lot of it can be attributed to the attractiveness of U.S. stocks and bonds from the global investor’s perspective.
A lot of investors see they can get twice the yield on a 10-year U.S. note than they can from a long-term German bund or other investments around the globe, so they’re gravitating toward the U.S. and buying those bonds, resulting in pushing up the price and pushing down the yield.
A lot of it just has to do with the attractiveness of our higher relative yields to foreign investors, as well as the fact that Treasuries are an instrument that nervous investors gravitate toward, and therefore benefit from the fear trade.
Right now, I would be less concerned about a recession around the corner or deflation, and would simply point to being the most attractive investment on the block.
EQ: In this week’s Sector Watch, you revisited the yield differential between the S&P 500 dividends versus the 10-year Treasury bond. That gap is as close as it has been in quite some time. What is the implication for stocks?
Stovall: What I found was going back to 1953, whenever the yield on the S&P 500 exceeded the yield on the 10-year note, it was very positive for stocks. The market gained close to 20% on average in the coming 12-month period whenever that happened, and rose in price more than 80% of the time. Obviously, 80% is not a guarantee but it is a fairly positive indication that the price appreciation plus the frequency with which a positive occurs is fairly high. Even when the yield on the 10-year note is higher for stocks but is within 1%, the average price change has still been in the mid-teens and the frequency of advance has even risen to 85%.
Like Pavlov’s dogs, you want to be fed frequently, and a very high frequency of advance hints at being fed more times than not in the coming 12-month period whenever interest rates are low relative to the dividend yield of the S&P 500.
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