As Sam Sees It: Recession or Rally? Either Way, Investors Need to Watch the Market

Sam Stovall |

Sam Stovall S&P chief investment strategistEach 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: There has been a lot of speculation that the economy is heading into another recession. Do you notice any similarities between how the S&P 500 has been performing in 2011 and how it performed in 2007 right before the Great Recession? If so, does it serve as any indicator that we're heading for a down market?

Stovall: The initial reaction is to think that when the market declines, as a result, we're likely to experience a recession. But, that isn't necessarily true because going back to World War II, there have been 83 times that the market has fallen by 5 percent or more, yet we've only had 11 recessions. So you can't automatically say that a recession is around the corner just because we've seen a decline. That said, however, going back to World War II, what I have found is that the S&P 500 tends to anticipate recessions by about seven or eight months.

So if the peak of this bull market occurred on April 29—it would be funny that the “Sell in May and Go Away” adage worked perfectly this time around—we would probably find out that we slipped into a recession in the latter part of the fourth-quarter of this year or early part of the first quarter in 2012. Of course, history is a guide and never gospel, but it could be a good starting point. So historically, the median decline in the stock market during a recession is 22 percent and the mean decline is 30 percent. Basically, we could see a garden variety bear market drop of between 20 percent to 30 percent that could take place between now and 15 months down the road, which is the average duration of market declines ahead of recession.

Currently, though, we still believe that there's still a greater likelihood that we will not slip into a recession, but obviously that risk has been increasing quite dramatically ever since we got worse-than-expected June payroll reports, and worse-than-expected second quarter GDP and revised first quarter GDP reports. The encouraging July jobs report allowed investors to breathe a sigh of relief, however.

EQ: Given that there is still a lot of uncertainty in the stock market and the economy is slowing considerably, what are some indicators that you'd like to see to confirm a strong year-end rally is still on track to finish around 1350 on the S&P 500?

Our 12-month target for the S&P 500 is still 1400, implying a 1285 year-end value. If we end up seeing a relatively quick bear market or correction—and we have seen many of those in the past—it could be allow us to have an end of the year rally. In 1980, we ended up falling 17 percent in fewer than two months, and back in 1990, we just touched the bear market level of 20 percent, but did so in only three months. If we end up with a market decline that is approaching 20 percent but gets done within two to four months, then that could be setting us up for your traditional third-quarter bottom and end-of-year rally.

EQ: One way for investors to protect their portfolios is by using dividend-paying stocks, which are a favorite among investors during bullish and bearish markets. What are some of the criteria that the S&P uses for its High-Yield Dividend Aristocrats that investors may want to incorporate in their strategies?

For the Dividend Aristocrats, we first started off by looking at companies in the S&P 500 that have increased their cash payouts to investors in each of the last 25 years. Then we decided to create an ETF that would replicate that, but in order to have enough stocks, we expanded that to the S&P 400 and S&P Small Cap 600. It's now called the High Yield Dividend Achievers, and these are companies from the S&P 1500, which are U.S.-based companies from our large, mid, and small cap universe that have increased their cash payouts to investors in each of the last 25 years.

To give you an idea on performance, since December 31, 1999, the S&P 500 has decreased by 12 percent on a price basis. But, we know that approximately 45 percent of the total return of the S&P 500 have come from reinvested dividends, and if you add in dividends, then we actually have a whopping 9 percent return on a cumulative basis. During the same time frame, the S&P 1500 High-Yield Aristocrats gained 152 percent. Of course, past performance is no guarantee of future results. If we do end up with another lost decade, there's no guarantee that you'll get this kind of differential performance. But when the underlying stocks are high-quality companies, chances are that these are companies that are going to want to continue with that stellar track record. The ETF that mimics this is SPDR S&P Dividend (SDY).

If you decide to select individual stocks, you could use the S&P Marketscope Advisor screening tool. I would suggest looking to the past, present and future. Look to the past for companies that have an average consistency of raising their earnings and dividends with a grade of B+ or higher. I prefer those that are above average or have an A- or better quality in rankings. I suggest you look to the present, meaning go for those companies that have at least a dividend yield of 2.5 percent or more. I would actually prefer 3 percent because then you're getting a 50-percent improvement over the S&P 500. Lastly, look to the future by selecting stocks that have a favorable investment recommendation by S&P analysts with either a 4 or 5-star ranking, meaning a Buy or Strong Buy rating.

Doing a screen of this criteria, I came up with 10 stocks, one that serves as a proxy for each of the 10 sectors in the S&P 500. (As of Aug. 1, 2011)

  • Consumer Discretionary: Hasbro, Inc. (HAS)
  • Consumer Staples: Altria Group, Inc. (MO)
  • Energy: TransCanada Corp. (TRP)
  • Financials: Royal Bank of Canada (RY)
  • Healthcare: Abbott Labs (ABT)
  • Industrials: General Electric Co. (GE)
  • Technology: Automatic Data Processing, Inc. (ADP)
  • Materials: PPG Industries, Inc. (PPG)
  • Telecommunications: AT&T, Inc. (T)
  • Utilities: PPL Corp. (PPL)

So if you are looking for a good dividend yield, and are not yielding to temptation by going after excessively high dividend yields, then you want to make sure the companies you're focusing on have a good track record of raising their earnings and dividends and have a Buy or Strong Buy rating by S&P analysts.

EQ: Any final thoughts you'd like to share?

You have to pay attention to the market. Rarely do analysts or economists predict a recession well in advance; the market does. However, that doesn't mean you should respond to each and every wiggle in the market. Be careful and don't get whipsawed, but at the same time, remember that fundamental data will confirm a recession only after it already occurred and after the market has slipped into very precarious environment.

Disclosures: Henry Truc has long positions in MO and GE.

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to: http://www.equities.com/disclaimer

Companies

Symbol Name Price Change % Volume
GWB Great Western Bancorp Inc. 40.42 0.99 2.51 416,293
GE General Electric Co 31.11 -0.23 -0.73 22,138,326
ABT Abbott Laboratories 38.43 0.53 1.40 9,514,677
ADP Automatic Data Processing Inc. 96.05 0.81 0.85 2,485,664
PPG PPG Industries Inc. 95.99 1.41 1.49 1,634,607
MO Altria Group Inc. 63.53 -0.46 -0.72 8,448,753
PPL PPL Corp 33.25 -0.09 -0.27 5,499,019
RY Royal Bank of Canada 66.28 0.21 0.32 939,261
TRP TransCanada Corporation 44.16 -0.03 -0.07 851,865
HAS Hasbro Inc. 84.38 0.40 0.48 956,255
T AT&T Inc. 38.63 0.02 0.05 20,773,441

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