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 Fed announced the official end to quantitative easing Wednesday. While it’s been largely expected by the market, does this serve as a milestone moment at all? Will anything change?
Stovall: I don’t think the end of QE3 signals anything important. It was an action that had never been taken before by the Fed and the jury is still out as to how successful it was. But from the standpoint of investors, I think they were focusing more on what the Fed was saying about their current assessment of the economy and trying to figure out when the Fed would likely start its rate-tightening program.
It seemed as if the statement Wednesday was balanced in that they left in the phrase “considerable time,” indicating that they are not anticipating raising rates imminently. Yet, at the same time, they indicated that inflation was probably something that was held down by lower energy prices, and that the overall economy and employment picture seemed to be improving.
Right now, I think investors are scratching their head trying to figure out if this means there is any change to when we should expect a rate increase. The consensus right now is that it should be some time in the third quarter of next year.
EQ: When you look at the market right now, it feels like the recent pullback is nothing more than a faint memory. While the 7% dip wasn’t a full correction, did it help to reset the market a bit to move higher from here?
Stovall: I think it helped to reset the dials a bit. If this ends up truly being a pullback (5% to 10% decline), then it was a textbook pullback. We declined a little more than 7%, which is usually what happens in pullbacks, and it took about a month to materialize. So if it is a normal recovery, it will take about two months to get back to break-even.
However, the last few pullbacks have taken less than a month to get back to break-even. If that’s the case this time around as well, we could have something to be very thankful for at Thanksgiving, meaning we are likely trading in new high territory. If you take historical observations one step further, the market has traditionally risen an additional 8% in the subsequent three months after recouping all that it lost in a pullback before experiencing another decline of 5% or more.
So this pullback may have reset some dials to allow us to move up to the 2100 level or so on the S&P 500 before we slip into a new decline that will shake investors’ confidence once again.
EQ: The market strength is a bit surprising if you consider that it’s coming during the second and third quarters of a mid-term election year, which is the weakest six-month period of the four-year presidential cycle. The S&P 500 is up over 5.5% so far during this period. We’re now heading into the best six-month period historically. What can investors expect?
Stovall: First off, investors are realizing that the sell in May adage was not a wise one to accept this year either. In 2013, the market was up 10% from April 30 through October 31. So far in 2014, the market is up 5.4% from April 30 through Oct. 28 of 2014, with only the Energy and Materials sectors in negative territory. So I think the old adage is still worthwhile because usually investors are a bit skeptical of market performances, but it does not automatically guarantee that we’d see some sort of decline.
As a result, I think investors cannot dismiss the six-month period that is usually strongest for stocks even though we did not have the very weak performance in the corresponding May-through-October period.
So if history does repeat, then we probably could see at least a 7% gain, which is the average for all years going back to World War II in that November-through-April period. If we are likely to see a return that is similar to those following mid-term elections, you can easily double that number and still be below the long-term average.
EQ: Earnings for Q3 seem to be coming in relatively strong so far. However, some companies have been punished for the lack of topline growth—most notably IBM (IBM). This has been an issue we’ve discussed in the past where companies were relying on ways to create EPS growth for shareholders through cost cutting and share buybacks, but not generating enough revenue growth. Have the chickens come home to roost?
Stovall: Well, the earnings are on pace to be up more than 6% so far if you combine actuals with the estimates of the remainder for this quarter. That is similar to what was expected at the beginning of the reporting period. From a revenue perspective, it still seems as if we’re going to be seeing about a 3% growth, which is a little bit softer than what had originally been expected.
However, we think we’re going to make up for it with a 3.9% growth in revenues in the fourth quarter, which would give us a 3.6% growth for the entire year. Granted, revenues are not climbing as rapidly as earnings are and I think investors would like to see revenues improve a little more in line with earnings before they believe that the economy itself is on the road to recovery.
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