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: The summer months are typically seen as some of the weakest-performing periods in the market, however, it doesn’t seem particularly too volatile in that very rarely do we get multiple meaningful declines. You mentioned in this week’s Sector Watch that the S&P 500 has already experienced its summer swoon. So are we in the clear for the near term?
Stovall: I think that’s a very compound question. First off, why are the summer months so volatile? I think it’s because you have most of the capital inflows occurring early in the year. Pension funds are adding early in the year, bonuses being paid are helping investors max out their 401ks, and IRAs funded by April 15. Also, if you’re getting a tax refund, you typically apply early.
Then in the summer, investors focus more on their tans than their portfolios. You have a lack of capital inflows and a lack of volume. Therefore, whatever volume there is, if it’s concentrated, can push the market one way or the other.
As a result, September is the worst month of the year on average for the S&P 500 and August is the third worst. So in a sense, it causes people to be cautious. With that in mind, however, because we did have a decline of close to 6 percent from May 22 through June 24, history says but does not guarantee that we already had our 5-plus percent decline for this summer.
Going back to World War II, basically 50 percent of the summers saw the beginning of a 5 percent or more decline. Yet, in about 90 percent of these observations, we only experienced one decline in excess of 5 percent. Only in 1967, 1986, 1999, 2006, did we see two declines of 5 percent or more during the May through September time spans.
EQ: Is this because the summer months usually lack the volume or market activity that would trigger more meaningful declines, perhaps maybe as a result of the “Sell in May” strategy?
Stovall: When we do get that selloff and recover from it, on average, it’s usually best not to be defensive for the rest of the summer. Once we have that summertime shakeout, you’re actually better off becoming a bit more cyclical, gravitating more toward the higher-beta side of the stock market than to remain defensive for the rest of the year. So right now in August, we’re going through a decline that would have to drop below 1625 on the S&P 500 to be tagged as another decline of 5 percent or more. While that’s certainly a possibility, the likelihood is that we won’t get down that low.
EQ: Looking at Q2 earnings season so far, about 90 percent of the S&P 500 companies have reported. While the beat rate is pretty high, the actual year-over-year earnings growth really cooled off after a hot start. What are your thoughts on Q2 so far?
Stovall:With Q2 reporting almost done, I think most investors are no longer paying any attention to earnings. They are focusing more on the Fed and what they will or will not do at their September meeting. That said, when you look to the second quarter in the beginning, S&P Capital IQ posted consensus estimates of 2.8 percent on a year-over-year basis. We ended up with something closer to 4.8 percent, so we ended up with 200 basis points higher, which is actually about half of what we normally have seen in the past 10 quarters.
So we normally have seen an outperformance of an average of 4 percent above initial estimate. You could say either analysts are doing a better job estimating the earnings projections or maybe companies are not managing expectations as well as they should have, or that maybe getting an improvement in earnings are tougher to come by.
EQ: Based on what the market has been doing recently, has investor optimism gotten ahead of the fundamentals?
Stovall: We are at least going through a correction in time, and maybe we will find that it ends up being a more meaningful correction in price as well. I think that because of a lack of alternatives, investors have been focusing almost exclusively on equities. They have been relatively optimistic about equities, about improvement in economic growth, recovery and earnings, etc., but usually you have peaks and troughs of optimism that end up being corrected in price decline or advances. I think right now because we are in a challenging month, it is possible that investor optimism has gotten ahead of itself and investors are very nervous of what will transpire in September.
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