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: In July, we discussed some reasons for why the bulk of the market was not really convinced of the current bull market. Stocks are up 5 percent since that time as most people have been holding their breaths for a top. Is this typical behavior for a market that we’re currently in?
Stovall: Yes, I would say that’s true. Bull markets tend to continue to advance as long as you have enough skeptics still on the sidelines who have yet to throw in the towel. What causes bull markets to take the stairs on the way up, and bear markets take the elevator on the way down, is that not everybody throws in the towel at the same time in a bull market. So little by little you have more people adding to positions, which causes the market to work its way higher. It’s when everybody rushes for the exits at the same time during a bear market that causes us to have that elevator approach.
I would say that for as long as this bull market remains unloved, it will remain alive.
EQ: As we’re still in the process establishing new all-time highs, does it seem like bulls are losing or gaining steam here?
Stovall: I think what’s happening right now is they’re sort of pausing and catching their breath. I described it recently as the bulls and bears appear to be playing musical chairs, anxiously circling the empty seat but unsure if the long or short version of “Light My Fire” is being played.
So both of them realize that a decline of 5 percent or more could occur almost at any time, but for right now, I think we’re just catching our breath before possibly moving higher.
EQ: As you stated in your Sector Watch report this week, we’re a bit overdue for a correction. What is the likelihood that we run into a correction before the year is over?
Stovall: As you know, the reason why I look to history is that it gives me a good starting point. It’s a guide, but it’s not gospel. It gives me an idea of what the probabilities are and tells me what has happened in the past, and therefore, what could happen—though it’s not guaranteed to happen.
The “Correction Course” article says that we are indeed due for a correction. On average since World War II, the time between market declines of 10 percent or more have been a median of 12 months, and a mean of 18 months. Yet, we have gone 25 months since the conclusion of the October 2011 correction.
But history also says that it won’t necessarily be on time just because we are due for one. There have been other bull markets that saw the number of months range from six to 60 months further than where we are right now before they ended up slipping into a 10 percent or more decline. What I can say, however, is that the longer we go between corrections, the greater the likelihood we end up having a bear market rather than just another correction.
From a seasonal perspective, however, we might end up seeing these fireworks occur after New Year’s. I assembled all of the pull backs, corrections, and bear markets since WWII and found that very few (only 3 percent) of the 88 of these observations started in December. The average for all 12 months is 8 percent. So it is almost three times the number of declines started in other months instead of December. January is also another month that we typically don’t see the beginning of very severe declines. If history repeats itself, and there’s guarantee it will, that would imply that February may be when we have the greatest chance of the next start of a 10-plus percent decline.
EQ: The October 2011 correction really walked the boarder of becoming a bear market, falling 19.4 percent. Could that potentially push the timeline of an anticipated correction a bit further out?
Stovall: A correction is a decline of between 10% and 20 percent, so it does not need to be as severe as what we saw in 2011. It could be as simple as a 10.1 percent decline to be counted as a correction. So because we had a deeper-than-normal correction in 2011, could we go a little bit longer before having another one? It certainly is a possibility.
EQ: A meaningful digestion of gains wouldn’t be a bad thing for investors as long as the cut isn’t too deep. What are some potential triggers in your opinion for a market that has been pretty resilient for the most part?
Stovall: First off, I would remind readers that a boxer is rarely felled by the punch that he expects. So I don’t necessarily think that whatever throws the market for a loop will be something that we’re already fretting about. By that, I mean the government having to come to a conclusion regarding the debt ceiling, budget, etc.
There are two reasons: we’ve already worked that into our model, and it’s taking place within the confines of a mid-term election year. I think the politicians remember all too well how badly they suffered in the polls because both Democrats and Republicans allowed the government to be shut down. So I don’t think it’s in anybody’s best interest to allow this to happen again. As a result, I think they are going to play nice and will probably come to an agreement without much fanfare on the debt ceiling, on the budget, and possibly wait until 2015 before striking some sort of a grand compromise on taxes. So it will probably end up being a nonevent.
I think I would be more concerned about a replay of what happened in the second quarter when the Fed was expected to start its tapering program. Or, maybe we get some bad news overseas, such as increased worries over deflation in Europe, or as it relates to China and other economies not pulling their weight in this global economic recovery.