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: Many investors and market commentators on Wall Street were expecting a “Santa Claus” rally to help push stocks higher to close out the year. It hasn’t happened yet, but what is the likelihood that it will still materialize as we hit the final stretch of 2011?
Stovall: Most investors, especially around the holidays, are eternal optimists. They’re going to be looking for some sort of rally even if it is the final week of the year. So I’d tend to say don’t count out a Santa Claus rally just yet, because like it says in the Stock Trader’s Almanac, “If Santa Claus should fail to call, the bear may come to Broad and Wall.”
So we need to have a bit of a Santa Claus rally because investors attempt to harvest tax losses by selling their stocks in early mid-December. If there is optimism toward coming calendar year, or at least the near- to intermediate-term, then investors buy into the market just before the year ends. If we don’t get a meaningful rally in stock prices, then that could be an implication that investors are not that optimistic about the year ahead.
EQ: In your latest Sector Watch, you noted that the S&P 500 has never declined in the third year of a four-year presidential cycle since 1945. Not only that, but if the market fails to increase by 10 percent, it usually suffers in the subsequent election year. Knowing this, does it add any extra significance to next week’s market performance in terms of implications for 2012?
Stovall: Yes, I think it does because a lot of this has to do with investor behavior. Investors realize that the political party that is in power wants to stay in power and traditionally they will try to stimulate the economy in year three so that the efforts bear fruit in year four. By then, voters will be happy with how the economy feels to them at the time they go back to the polls and will, hopefully, re-elect the sitting president.
Investors, however, don’t want to wait around until the fourth year to see if this comes true. They’re anticipators and will buy in during the third year in anticipation of it bearing fruit in the fourth year. So what’s interesting is we’ve never had a decline in year three of a presidential cycle since World War II. You actually have to go back to 1939 to find a 5.5-percent decline in that third year. Then, you have to go back earlier than the 1930s to find the other one.
Furthermore, I discovered that if the market advance was one-half of the average price increase of the third year–which has been 17 percent since WWII–then we end up having a sub-par fourth year of the president’s term in office. Specifically, any time we had a return of 8.5 percent or less we ended up having an average price change of minus 10 percent in the fourth year. Of the six observations where this occurred, the market fell five times. So it’s not a good thing if we don’t get a meaningful rally in the third year of a president’s term in office.
EQ: Depending on how the market moves in the final week to close out the year, will that have any effect on S&P Capital IQ’s projection of the S&P 500 for 2012?
Stovall: Not really. I use history as a guide, for it’s certainly never gospel, and even if something worked 100 percent of the time, there is no guarantee that it will work in the year ahead. But from the standpoint of potential for volatility, as well as the possibility that next year could end up having a muted overall return, that could be justified based on the fact that we really had an anemic third year of a president’s term in office.
Our belief is that we probably could see a bit of an advance in 2012, and our year-end target is 1400 for the S&P 500. Based on the Dec. 20 close of 1241, that would give us a gain of just under 13 percent, which certainly is a nice advance. But depending on how we end the year, that could end up being an even lower double-digit gain or even a high single-digit advance.
The market is currently trading at a discount to the median P/E since 1936, and S&P Capital IQ is still reporting a growth of about 8 percent in earnings for 2012. So our belief is that with valuations being as attractive as they are right now, it still seems as if we have the makings of a nice year, but not a great year in 2012.
EQ: Economic numbers for the U.S. have been steadily improving, with employment and housing showing some small signs of stabilizing. However, they’ve been getting overshadowed by the uncertainties around the globe, primarily Europe. Do you think that will be the case in 2012 or can the U.S. decouple from Europe’s crisis?
Stovall: We learned in 2008 that the world is more in tune with itself than less, and “decoupling” was a term that got a lot of people in trouble, thinking that the emerging markets would not bear the brunt of the problems in the U.S. or that international economies and stock markets in general would also not experience problems. We could not have been further from the truth. So, I would say think of world economies as one long freight train being pulled by a variety of engines. Unfortunately, we are still on the same track, and if one of the lead engines happen to derail, there’s not much that anybody can do about it. It will affect the entire world.
My belief is that there are three things that investors are focusing on. They are feeling more at ease about the U.S. economy, which is probably still growing at a half speed rate, but moving further and further away from the precipice of recession. In Asia, certainly we’re keeping an eye on China to make sure that they are able to engineer a soft landing rather than suffering through a hard landing. But the real uncertainty remains Europe.
Even though only about 14 percent of revenues for companies in the S&P 500 come from Europe, it’s still 14 percent and it’s still something that could adversely affect our exports and our sales if Europe does slip into a deeper recession than we are currently forecasting. Right now, we think that they will experience a mild recession during the first half of 2012 and then slowly emerge. The real GDP could eek out a very, very slight advance for all of 2012 in the eurozone. If this area does happen to suffer more than we currently expect, then the U.S. could also feel the effects, and if Europe slips too deeply into recession, they could drag us with them.
EQ: The Asian markets sank on news of North Korean leader Kim Jong Il’s death. What kind of impact do you think this could have on the stability and projected growth of that region, primarily on the economies of China and other emerging markets?
Stovall: I don’t really think that you can pinpoint how specifically China or the other areas would be affected by a change in leadership. What caused the nations to be unnerved is that North Korea is a very secretive society and no one knows how the transfer of power will take place.
We are under the assumption that it is going to be Kim Jong-un, his third oldest son, who will be taking over the leadership reigns. We really don’t know anything about him and what his policies could be. All we know is that they have nuclear capabilities and every so often they like to rattle their sabers to get attention. The concern is that they could rattle it in such a way that it causes problems, not only on a political front but on an economic one as well.
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