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: In the first two weeks of September leading up to the Fed’s announcement of QE3, stocks were up about 3.8 percent. This week, stocks have fallen about 0.4 percent as of the close on Tuesday. Is the market suffering from a stimulus hangover?
Stovall: I think because the S&P 500 advanced more than 16 percent since the closing low of June 1, it’s entitled to a little bit of a breather. If you wanted to get technical (pun intended), you could say if we’re looking at retracement levels in the advance, that could bring the S&P 500 down to the 1425 level before our Chief Technician Mark Arbeter believes it would represent a good buying opportunity once again. From a technical and historical standpoint, it looks like the S&P 500 could close anywhere from 1500 up to 1550-plus by the end of this year. If you include fundamentals, however, the timeline gets dragged out a bit. So based on earnings projections, we would probably need to wait until mid-year 2013 to hit that 1500 target.
EQ: What were your thoughts on the Fed’s decision to provide an open-ended strategy, as opposed to the lump-sum approach it used with QE1 and QE2?
Stovall: I think it’s not only a situation of providing liquidity, but also trying to inject confidence. So we shouldn’t call it QE3; we should call it QE Infinity, because that’s now what it is. It will continue until the Fed deems it no longer necessary. So I think it did surprise people because it indicates that the Fed truly wants to do all that is within their power to help support and promote economic growth, as well as promote the addition of jobs. At the same time, it also indicates the U.S. Fed is on the same commitment footing as the European Central Bank. So I would say that those two central bank leaders were probably not competing with each other, but certainly were working in a coordinated fashion.
EQ: The easing plan is expected to hurt the U.S. dollar, which as you noted in this week’s Sector Watch, could actually be a good thing for stocks. What is the correlation between the dollar and the S&P 500?
Stovall: For those who went through graduate school studying the U.S. stock market and looking at the factors that could affect stocks, they’ve been told over and over again that the dollar might have some impact but not a real direct one, and they’re right. Since 1990, the correlation between monthly percent moves in the S&P 500 and the U.S. dollar has recorded a correlation of only -0.20, which means that it moves slightly in opposite directions, but more times than not, they don’t really have much of a correlation at all.
However, in the past 36 months, in the period where investors have been focusing on macro events—whether risk is on or off globally—it has been pretty much signaled by whether the dollar has been strengthening or weakening. When the dollar has strengthened, it would imply that risk is off and investors are not willing to take on additional risk, and are hiding out in a currency. However, when the dollar falls, the implication is risk is back on and investors are willing to take on more risk because the things that worried them have begun to dissipate. So interestingly enough, in the past 36 months, rather than the long-term average of -0.20, the correlation has jumped to -0.70, therefore implying much more negative correlation to the dollar that we have seen over the last 22 years.
EQ: In addition to the broader S&P 500, you broke down the correlation by sectors and sub-industries. Which sectors and sub-industries stand to benefit the most? Were there any ones that surprised you?
Stovall: Well first off, I thought it was interesting that all 132 sub-industries in the S&P 500 posted negative correlations with the dollar over the past 36 months. So there was not one single sub-industry that was even at 0, which would imply no correlation at all. I guess it’s no surprise that those with very low correlation are the ones that are very domestic in nature, such as General Merchandise Stores as well as Integrated Telecommunication Services, and Home Improvement Retail. There was also a group that was very surprising; Gold was among the 10 sub-industries with the smallest negative correlation. I think that has more to do with the fact that these are gold mining stocks and not the gold metal itself. So because some of the gold mining stocks have not, themselves, been trading with a very high correlation to the metal, once you look past the initial thought, you can understand why.
The groups with very high negative correlation with the dollar include Personal Products—which is another word for cosmetics—because of the global nature, and Diversified Chemicals, also because of their global nature. There are also some computer areas like Data Processing as well as Systems and Software with high negative correlation, because Information Technology is, if not the sector with the highest percentage of revenues coming from overseas operations, it is certainly in the top two.
