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: Earlier this week, the S&P 500 crossed the 1900 level on an intraday basis but was not able to close above the threshold. Without getting overly technical, could this suggest that we may be seeing a top here?
Stovall: I can’t say I think it represents a top because usually century levels like 1900 on the S&P 500 or 16,000 on the Dow do represent psychological barriers. I like to say these kinds of levels act like rusty doors and require several attempts before they finally break open.
That said, I am still reminded that we are in a seasonally challenging period for the market–the summertime months—and that’s especially so during mid-term election years. Also, we’ve gone an exceptionally long time without a decline of 10 percent or more. However right now, I would tend to say that the path of least resistance remains higher, and until we really do get a meaningful decline breaking below some trend lines, you have to assume that the trend remains your friend.
EQ: The small-cap segment continues to get punished by the market. Could the broader market hold up if the small cap market continues this trend?
Stovall: I think that if it continues to underperform, then we’re probably going to see history repeat itself. What I mean by that is every year since the Russell 2000 was started in the late 1970s, whenever the larger-cap index like the S&P 500 or the Dow beat the Russell 2000, the large cap index suffered through a decline that averages above 10 percent during that calendar year. Of course, we won’t know that the large caps have beaten the small caps until the end of the year, but it certainly seems to me that we’re heading in that direction.
The smaller and more volatile issues are being shunned at the moment and it sort of reminds me of the old saying, “When the seas get rough, sailors prefer a bigger boat.”
EQ: The housing market has been a strong part of the economy’s recovery. But there were concerns that we were due for a bit of a breather heading into Friday’s housing start numbers. What sort of implications could this have on the market?
Stovall: Housing is a very important part of the overall economy. If you look to the homebuilding index as a guide, it peaked in September 2012 but then broke below its 200-day moving average in February 2013. It’s now just beginning to bottom about one-standard deviation below its mean since 1995.
So stocks have anticipated what has turned out to be a slowdown in housing because of the bad weather we experienced earlier this year. Historically, seven of the last eight recessions were preceded by a year-over-year decline of 30 percent in housing starts. So I would tend to say that is a fairly reliable indicator. If housing starts have experienced sharp declines, it really indicates that a recession could be right around the corner.
The reason I say that is the expectation for the second revision to the first-quarter GDP data we’re expecting to see a 0.2-percent decline, and the rule of thumb is that two quarters of GDP declines indicate a recession.
So I think investors were worried, but the housing starts data released on May 16 provided investors with a little bit of breathing room because of the very strong number that we got for April.
EQ: Some of our recent conversations have discussed the first quarter serving as a dumping ground. With April’s housing start data, could this indicate that the economy may actually be in better shape than first-quarter GDP suggested?
Stovall: Absolutely, and I actually think that could be a possible undoing for the stock market. We are finally seeing retail sales, housing data, and other factors that are pointing to a more convincing recovery in U.S. economic growth. The big concern is how quickly we turnaround, and therefore, what kind of impact it could have on inflation.
This week’s PPI and CPI both were stronger than anticipated, and I think investors may be beginning to worry that if we get an upward spike in inflation, that would not be good. The Fed has said they’re going to take their time to begin raising interest rates, but if the data pretty much pushes them in that direction, I think investors would become spooked.
