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: It looks like the pullback the bears and dip buyers have been waiting for might finally be underway, at least from a technical standpoint. Can you discuss what you found when looking at the moving averages of the S&P 500?
Stovall: The S&P 500 has not fallen into official pullback territory, which is a decline of 5 percent or more. However, what I have found is that we may have started in what could be the long-awaited digestion of the 29-percent advance we experienced from early October through the first week of April. What I found was that the S&P 500 was more than 12 percent above its 200-day moving average, which was about 300 basis points above the one standard deviation from the mean. This implies that we got overstretched and that the market was vulnerable to some sort of news that could cause a shakeout in prices. So our belief is that the S&P 500 could pull back to a range within the 65-day to 50-day moving averages, which would be between 1350 and 1370 on the S&P 500 before we probably bounce and then start to head higher.
EQ: Currently, S&P is expecting a pretty mild pullback on the S&P 500. However, that may not necessarily be the case for some sectors. Which sectors are susceptible to a deeper pullback?
Stovall: Those that ended up being better performers in the six-month period of October through early April are the ones most susceptible to a decline. When you take a look at some of the sectors such as the S&P Financials (XLF), Technology (XLK) as well as the Consumer Discretionary (XLY) groups, they rose anywhere from 30 percent to 40 percent. The S&P 500 itself, meanwhile, was up less than 30 percent. So those are the ones that are furthest away from their 65-day moving averages. Through April 5, if we saw the Technology sector come back to its 65-day moving average, we could see the index fall 7 percent. For the Financials and Consumer Discretionary categories, if they came back to their 65-day moving averages, they would likely see a decline of 5 percent. So it's still within what I call the pullback zone of 5 percent to 10 percent, and it's enough to remind us that markets never go straight up.
EQ: Which sectors may hold up better?
Stovall: Certainly those groups that are relatively defensive in nature--such as Healthcare (XLV), Consumer Staples (XLP), and Utilities (XLU)--could hold up a little bit better. The Materials (XLB) and Energy (XLE) groups actually are already below their 65-day moving averages. So we might find that a lot of the rotation out of these groups has already occurred, but we'll just have to wait and see how earlier reports in first-quarter earnings season come in. Traditionally, your defensive groups hold up best, and then possibly those that have already taken it on the chin might end up falling a little bit less than those that are still quite a ways away from their 65-day moving averages.
EQ: If this pullback plays out as expected, what do you need to see to confirm that S&P 500 is still on an uptrend for the full year?
Stovall: First off, we are in an uptrend until we break below trendline resistance and break below the moving averages themselves. Until that happens, we are definitely in a bull-market mode. So I would want to see the S&P 500 bounce off of its 65-day moving average. It could rise but then come back and retest that 65-day moving average, and if it retests successfully and doesn't break below it, then that would be one indicator that we are still in this bull-market mode. Another indicator could be that we end up going to the 200-day moving average, which is quite a bit lower. That would fall into the 1200 zone, so it is not an area that I would like to see us pull back to. But I would tend to say that the overall trendline would apply, and that we could see the S&P 500 come back to the low 1300s, and that too would still be within the confines of an ongoing bull market.
EQ: The market has experienced a pretty significant drop so far this week ahead of earnings. How worried do you think Wall Street is for Q1 earnings?
Stovall: Wall Street was pretty worried because a year ago we saw a near 20-percent increase in year-over-year operating results, whereas this year, we're looking only for about a 1 percent increase in earnings. Also, we are expecting that seven of the 10 sectors could be posting year-over-year declines in earnings and so, as a result, there really is an awful lot of uncertainty as to how well we're going to be doing in this quarter. However, most people realize that the first half of this year will be under review and investors are a bit skeptical about the growth in the first half, mainly because of the weakness in Europe and the fall out of that weakness occurring in Asia. So should we see Europe emerge from recession later this year, then that would be a positive for both U.S. and Asian economies.
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