Each week, we tap the insight of Sam Stovall, Chief Equity Strategist for S&P Capital IQ, for his perspective on the current market.
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EQ: On Thursday, the S&P 500 managed to close above the previous all-time high of 1848 after several days of failing to do so despite trading above that level on an intraday basis for a few sessions. Does this mean the market is in the clear from the recent pullback?
Stovall: It means that the pullback has ended because we have eclipsed the starting point and have ended a little higher. However, I wouldn’t necessarily say that all of our worries are behind us, primarily because when I speak to market technicians, they are concerned by the lack of enthusiasm associated with this recovery since the Feb. 3-bottom.
Traditionally, we need to see a retest of the decline to feel that it truly is over. So even though we’ve concluded the pullback, I don’t think we are in the clear totally, and we may have to endure another 3 to 4 percent decline to make us feel more comfortable that we’re not going to fall into a deeper fall associated with this pullback.
EQ: February is typically a weak month for the market, and last year you predicted that a positive January and February combination was a bullish sign for the market. With January being a down month this year, and February looking to end in the green, is there any historical significance that investors can take away from this role reversal?
Stovall: I think this is a fairly consistent performance following a down January because usually investors take a move in one direction as an opportunity to go the other way over the subsequent month. So using the “as go January, as goes the year” scenario, I still think that there is a lot of uncertainty surrounding this market because we did start on such a bad footing.
I would tend to say that no sirens, no flags, and no indication that the all-clear is here, so I would remind readers that we are in a mid-term election year. Historically, these years have been the most volatile and have experienced the greatest average decline in stock prices. So it could end up being similar this year as well.
EQ: With the market reaching record highs, many investors may naturally feel that prices are getting ahead of fundamentals. Based on what you examined in this week’s Sector Watch, is that the case in regards to earnings since the bull market began?
Stovall: If you looked only at the stock market’s performance in both price and earnings in 2013, you would think that stock prices are well ahead of fundamentals. However, if you take a longer view and look back to the 2009 bottom, or the 2007 top, you’d see that both prices and earnings have advanced at almost the exact percentage.
That would indicate to me that prices have not gotten ahead of fundamentals. Also, if you look at trailing P/E ratios—whether it’s based on operating earnings since 1988 or GAAP earnings since 1948—based on the inflation we’re experiencing right now, history says that we are still at a slight discount to the norm under such circumstances.
EQ: You suggested that in a pullback/correction environment, investors may want to consider a 5% threshold allocation strategy into stocks. If the market is preparing to inch higher, would you suggest a similar percentage threshold strategy?
Stovall: Basically, what you’re asking is if I encourage dollar-cost averaging, because you’re going to be adding to your positions whether prices are going up or they’re going down. I think that dollar-cost averaging is a good way to force investors to continue to add to the market. Stock prices have advanced an average of 70 percent of the time since 1945.
So you want to find ways to stop your emotions from getting the better of your trading habits. I still believe, however, it’s best to start by being fully invested and then accumulate cash through non-reinvested dividend distributions and your personal earnings to be deployed into the market at these 5-percent decline thresholds
That is a very good way to put money to work, while at the same time, showing that you have the green thumb when it comes to market timing.
