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: Last week’s sell-off following the election was a bit perplexing for many investors. Aside from the market essentially projecting an Obama re-election, stocks also usually perform well when the incumbent wins. Can you tell us more about how the market’s reaction to this election is on pace to differ from historical performance?
Stovall: Going back to 1900, the S&P 500 has traditionally done relatively well in the latter part of the year after an incumbent has won reelection. In the Novembers following an incumbent’s reelection, the market has gained about 1 percent, and has risen about 60 percent of the time. In December, the market has risen close to 3 percent, and has advanced 78 percent of the time. So the market has done relatively well in the final months of an election year when an incumbent has been reelected. However, the interesting thing is that the market does not do very well when the challenger gets elected. This is perhaps because it injects a new round of uncertainty as you’re essentially swapping a known quantity for an unknown quantity. Usually the market declines after Election Day, but then seems to meander higher as the month progresses. So this time around, it’s a little bit different than the normal routine in that the market has basically headed south on the day after election and really has not looked back.
EQ: You also found a historical point of reference for the last time this happened, which was the 1948 reelection of President Truman, in this week’s Sector Watch report. What can we learn from that example?
Stovall: I thought it was interesting that back in 2011, the S&P 500 got absolutely nowhere. We ended up almost exactly where we had started the year for a 0.0-percent change in price. The only other time since 1900 that a third year of a president’s term in office was equally flat was in 1947. Normally, the market has its best showing in the third year.
However, 1948 was similar to 2012 in that you had a Democratic president that is at odds with Congress, and at least from the perspective of Wall Street and business, the president appears to be unpopular. So leading up to the election in 1948, the market was higher by about 9 percent only to then decline close to 12 percent in the 30 days following the surprise reelection of President Truman over the highly favored Governor of New York Thomas E. Dewey.
I don’t think people were as surprised by the reelection of President Obama in 2012 as they were by the reelection of Harry Truman. At the same time, those on Wall Street were keeping their fingers crossed hoping that either Governor Romney would be elected, or the Senate would go Republican, and therefore offer a bigger resistance to the tax increase program that had been put forth by the President. So we have to wait and see if history repeats itself this year. If it does, and if history then carries through, we could always look to December, which rose 3 percent in 1948, and 10.3 percent during the calendar year of 1949. So if we do get a little bit of a sell-off here in this November, maybe we can look to history to provide us a little bit of solace for December and next year.
Stovall: Is it possible that the market’s reaction has more to do with a gridlocked Congress and their inability to deal with impending fiscal cliff, versus a preference of a Romney administration over an Obama one?
Stovall: That’s definitely possible because history says the market does the worst whenever we have a split Congress, because Congress therefore gets nothing done and ends up impeding rather than leading. The average price change for the market under a split Congress since 1900 has been less than half of the average advance whenever we have had a totally unified government—meaning when the President and both houses of Congress were from the same party. So if we ended up with a Democratic president and a totally Republican Congress, investors would’ve felt there would be more compromise as to the upcoming tax reform, and therefore the rich—as the President likes to refer to them—would feel as if they’re not going to be run over by a steamroller.
EQ: While third quarter earnings came in better than expected, it seems that corporate guidance for the fourth quarter and the resolution of other economic headwinds did not turn out as positive as investors had hoped. Are you concerned about the prospects of a year-end rally?
Stovall: Right now, S&P Capital IQ expects third quarter earnings to come in at a gain of 2.4 percent as compared to a decline of 1.8 percent that was forecasted on Oct. 1. So you could say that the third quarter numbers ended up being better than expected. Yet, at the same time, the earnings expectations for the fourth quarter came down from 9.6 percent to 5.3 percent. So we definitely see a deceleration in earnings growth in the coming quarter. As for all of 2013, the numbers have come off a bit as well. We were expecting an 11.7 percent gain on Oct. 1, and are now projecting a 10.1 percent earnings advance.
I think investors have to start seeing some real or anecdotal evidence indicating that the earnings slowdown is over and that the market will be able to expect better earnings in the quarters ahead. If you simply map out the year-over-year percent change in quarterly results from the beginning of 2011 through the end of 2013, we definitely see a pronounced “V” shaped bottoming occurring in the summer of 2012, with the recovery occurring starting in the fourth quarter of this year and into 2013. However, the slope of that V is a lot shallower today than it was on Oct. 1. So I guess it’s ending up being a lowercase “v” rather than an uppercase “V”, and as a result, investors have become less enthusiastic about 2013.