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: The 11th-hour miracle came and the debt ceiling was raised to prevent a default, but stocks seemed to fall even harder after President Obama signed the new bill. The S&P 500 ended Tuesday down over 2.5 percent. What are your thoughts on how the market reacted to the debt deal?
Stovall: I think a lot of us were taken by surprise, myself included, thinking that we would have at least one or two days for a relief rally. It ended up being a relief rally of only one or two hours. This indicates to me that the market is worried about several additional things that are likely of greater consequence. Investors may be worried that the debt ceiling increase was not enough to placate all of the ratings agencies, or that there continues to be growing concern that the recent deal to bail out Greece again is not enough to satisfy everyone. But probably the greatest concern is that–because of what we saw with the most recent GDP data–the U.S. economy is steering toward a double dip recession.
EQ: The entire debt ceiling debate may be a good example of a topic you wrote about in your latest Sector Watch report. In it, you wrote that historically, the market performs better when the President and Congress are unified. What do you believe are some reasons for that?
Stovall: The old saying, “Gridlock is good,” is a cynical statement that suggests that if Congress cannot agree on anything, that means they cannot get in the way of capitalism. Yet, history tells a different story. Whether you go back to 1900 or 1945, the results show the market ends up producing average annual returns under a split Congress that are less than one half of what we would get under a unified government.
The reason is that under a unified government, if the President initiates legislation, then Congress—which is of the same party as the President—would rubber stamp the legislation, stimulating the economy, boosting corporate earnings and propelling share prices. Yet, under a split Congress, basically what happens is Congress impedes, rather than leads. As a result, corporations are less willing to spend money on the books because they’re not sure what new legislation could help or hurt their earlier decisions.
EQ: We know that healthcare and defense stocks took a hit because of the targeted spending cuts in the debt bill. What sectors do you think were most immediately affected by the new budget?
Stovall: The new budget pulled back on stimulus, defense spending and healthcare–in particularly, the managed-care areas. So we’re basically finding that, at least in the near future, a defensive posture is still the appropriate stance. This means gravitating toward the consumer staples stocks and to a lesser extent, the utilities issuers, mainly because investors are still reaching for yields. They’re still looking for companies that have consistently raised their earnings and dividends. The healthcare sector is usually in that defensive camp, but there is uncertainty there because healthcare is directly impacted by the most recent debt ceiling legislation.
Also, energy stocks might end up holding up better than the overall market. A lot of people forget that energy is a defensive sector. It’s almost like asking someone who the fifth Beatle was since most people only think consumer staples, healthcare and utilities when they think defensive. Since World War II, energy stocks have posted the fourth best relative performance, outperforming the S&P 500 and doing so by a frequency in excess of 75 percent of the time.
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