As Sam Sees It: The Best Offense is to Stick With Great Defense

Sam Stovall  |

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: The S&P 500 has been up about 16.5 percent since bouncing off the November lows. With May just around the corner, is this party getting ready to die down for investors?

Stovall: History would say, “Yes”, but you never really know for sure. Over the last week or so, investors were thinking that we were getting ready to go through some sort of a digestion of gains, but the market just took off this week, again frustrating those bears that are looking for a better entry point.

However, we have typically seen stronger-than-average May through October results in years where that period was preceded by positive performances for the S&P 500 in both January and February. So maybe it ends up being the same this year as well since usually a good start for the year ends up providing momentum for the May through October period. Since World War II, instead of only getting a 1.2-percent gain in the S&P 500 from May through October, that average climbed to 3.9 percent following strong January and February results.

EQ: Instead of the “Sell in May and Go Away” approach, you’ve always advocated that rather than selling out of stocks, investors are better off incorporating a rotation strategy. Can you elaborate on this?

Stovall: On average, the S&P 500 has risen about 7 percent from November through April, and only 1.2 percent from May through October. Now, 1.2 percent annualized is still an awful lot better than what you’d get in the money market funds. Also, if you sold out of stocks completely, you would have missed out on strong results in 2012, 2009, and 2003, just to name a few. So you probably don’t want to sell out of the equities market in its entirety.

What I have found is that by sticking with stocks, but gravitating toward the defensive Consumer Staples and Health Care sectors, investors would have substantially increased their returns, while at the same time reducing their volatility. So you could stick with stocks and let a rising tide lift all boats—if that’s the case for the summer—but you’re also more defensively positioned should we ultimately come up with that digestion of recent gains.

EQ: As you’ve noted before, the current rally has been led by these defensive sectors. Does that have an impact on how investors should approach this coming six-month period? What if they’re already largely in Healthcare and Consumer Staples?

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Stovall: Those defensive stocks have done very well, and I think it’s for reasons that could allow them to continue to do well. In particular, for investors who are entering into this rally a little bit late and therefore are fearful of buying into the higher beta sectors, the thought is to gravitate toward the defensive sectors because the demand for the products and services will remain fairly static. If the market does go down, these groups might not be beaten up as badly as the cyclical sectors.

Also, there is a lack of higher-rate alternatives out there. So the defensive groups tend to offer a higher dividend yield than the cyclical sectors. Lastly, because the tax question was finally resolved early this year with the fiscal cliff resolution, investors are saying that maybe it is worthwhile to focus on the higher-yielding defensive stocks. In addition to the Fed is keeping rates low, investors may also be thinking that they won’t be penalized by looking at dividends versus capital gains because they’re still going to be getting much more favorable tax treatments with dividends than they would with ordinary income.

EQ: As you covered in this week’s Sector Watch report, this rotation strategy also applies to the subsets of the S&P 500, correct?

Stovall: That’s correct. When I say subsets, each one of the broader benchmarks—the S&P 500, S&P MidCap 400, S&P SmallCap 600, as well as the S&P International Developed and Emerging Market indices—have smaller subsets that are called the Low Volatility index. For instance, for the S&P 500, you take out the 100 stocks that have the lowest trailing 12-month standard deviation, and that gives you the low volatility subset.

Had an investor decided to sell out of the S&P 500 (SPY), and buy into the Low Volatility component of the S&P 500 as seen in the PowerShares S&P 500 Low Volatility (SPLV), that would be an example of the kind of rotation that one could take at the end of April and buy back into SPY at the end of October.

EQ: Looking at Apple (AAPL), the company reported strong earnings and even announced a $100 billion plan to return cash to shareholders. Yet, investors seemed largely unmoved based on its current price performance. What are your thoughts on what’s happening here?

Stovall: First off, we’re seeing that Apple is having less and less of an influence on the overall markets because, despite Apple’s continued weakness, the overall market has been improving. But I think people are just thinking that maybe it will take a while before Apple turns around. As they have mentioned, they’re not going to be introducing new products until much later this year, if at all.

S&P Capital IQ’s equity analysts continue to have a Strong Buy recommendation on shares of Apple, however. We see the fundamentals largely bottoming in the current quarter, and note a new $50 billion buyback program that we expect will start being deployed within a week or so. We did lower our 12-month target price to $550 from $600, owing to our revised relative analysis. We also reduced our earnings estimates for fiscal 2013, which ends in September, to $41.04 from $44.29. Basically, it reflects our updated and less favorable outlook for revenues, gross margins, and taxes.

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not necessarily represent the views of 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:

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