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 market has taken a pretty big tumble this week as mixed earnings, slowing U.S. economy, and Europe’s troubles continue to weigh on investors. The one hope seems to be the Fed making a move. Do you think this has added pressure on the Fed to act sooner?
Stovall: I think the Fed reads the newspapers and watches the daily events like everybody else. However, if your mandate is to try to maintain specific levels of economic growth while, at the same time, keep inflation down, the Fed might not be too worried about the overall stock market. Although, it does obviously focus on what is driving the stock market. In the past week, from an economic perspective, the two main driving forces out of the U.S. have been the existing home sales and new home sales, both of which came in much weaker than expected. Existing home sales fell by 5.4 percent in June and new home sales fell by 8.4 percent in June. So the market responded negatively to this economic data, combined with the sliding expectations in corporate revenues and profits as well as with additional worries about global economic growth. So the Fed certainly is continuing to focus on what drives equity prices.
EQ: Could it be possible that focusing too much on the Fed be a mistake, given that much of the problem with the U.S. economy hinges on Congress’ ability to resolve the Fiscal Cliff?
Stovall: In a way, it’s like building a house or tearing one down. You have to focus on one building block at a time and do it piece by piece. You can’t focus on them all at once. The Fed is an intricate component of the overall recovery of the global economy as well as the global stock market. It can only do what it has the ability to do, which is basically affect the money supply and possibly have an effect on short and long-term interest rates. Interest rates are obviously very important to the investing equation because they help us to discern intrinsic value based on a discounting interest rate. They also help to figure out the cost of doing business in terms of issuing bonds. They also help us to figure out the likelihood of substitution should interest rates rise to a point where it makes typically less volatile bonds more attractive to nervous investors.
Of course, the Fed engaging in QE3 will probably not be enough to stop the U.S. economy from falling off of the fiscal cliff should Congress continue to be in a stalemate as we head into 2013. Most logical minds, however, assume that Congress will actually see the light and resolve their differences before the calendar year ends. And if not, then certainly they may come up with some sort of agreement that delays the fiscal cliff. But that’s not guaranteed, and so the Fed as well as investors have to prepare for the unexpected. Globally, we really don’t have much control other than making recommendations to European leaders in terms of working more closely together, and also finding that the U.S. central bank could be more supportive of efforts by other global central banks. While the Fed can’t resolve all the problems, it can certainly resolve some of the problems, and that’s why investors still need to pay attention to what the Fed does.
EQ: It seems like investors are getting some mixed messages from Q2 earnings and guidance, possibly signifying the uncertainty going forward for the near term. What are your thoughts on what you’ve observed thus far?
Stovall: What was interesting was S&P Capital IQ thought that consensus earnings would decline by 1 percent in the second quarter. We saw the expectations get to as low as a minus 2.25 percent, but now we’ve recovered to a minus 0.6 percent. This means that we’re doing a little better than we thought we would do at the beginning of this second quarter reporting period. The one area that has been a continued disappointment, however, has been in the area of revenue growth. Early in this quarter, we thought we would be seeing revenue growth of 5.4 percent, but it now appears that we will only be getting 1.8 percent in top-line growth. The big concern is that we really can’t expect to see company profits improve much further because they have engaged in several years worth of cost-cutting efforts and have engaged in a series of share repurchase programs. So sooner or later, the top line will have to expand in order for earnings to continue to advance.