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 as a whole is having a tough time right now. The S&P 500 broke through pullback territory, and is on the cusp of hitting its first correction since 2011. Leading up to this point, it seemed like the market understood that a correction was coming, but why does the panic and sentiment right now seem like it might’ve caught investors by surprise?
Stovall: I think in many ways they were caught by surprise, thinking that we’d see more of a rounded top rather than a straight plunge downward. People were possibly overextended and a little longer than they would otherwise have wanted to be.
Second, while people know that a correction is coming, usually what causes a correction is that we have the potential of game-changers enter the Wall Street equation. In this case, it’s Ebola combined with the uncertainty that investors have as to how quickly and how fast this virus will spread. We are also very quickly finding out that the medical community is not talking with each other or doing what most people think they should be doing. So there’s a concern about the virus, as well as the authorities who are supposedly protecting us from that virus.
So even though we are aware that a pullback, correction, or even a bear market is around the corner, the reason we feel as if it takes us by surprise is because we did not factor in unanticipated events into the equation. That causes some people to say maybe a correction is not all we’re going to endure. We might end up with a new bear market like in 1987.
EQ: So the fear of Ebola is being attributed as one of the primary concerns driving the sell-off and panic. With only two reported cases after the initial patient came to the U.S., do you think it is being blown out of proportion or do you think this reaction is justified?
Stovall: I’m not a medical expert but I think that people are feeling concerned because even though we are aware that it has been brought on to our shores, we’re not doing a very good job of keeping it isolated.
You are right that this is not the only concern that Wall Street has to deal with. What’s happening right now is Wall Street is weighing a what-if mindset. What if Ebola ends up spreading out of control? What if ISIS turns Iraq into a new terrorist state, something like North Korea? What if Europe does go into a triple-dip recession? What if leadership in Greece does decide to remove itself from the EU?
So I think there’s a lot of unquantifiable concerns that are very hard to model floating out there even as most investors are thinking they should be buying these lower prices because the fundamental foundations really have not changed. In fact, third quarter earnings are coming in a little better than expected, and guidance does not really seem to be off-putting.
EQ: We still have the mid-term elections next month and earnings, while good so far, is still in the early going. Are there more headwinds coming to add to the downtrend?
Stovall: I think most of Wall Street anticipates that the Republicans will take the Senate and maintain their control in the House of Representatives. I don’t think that control in the House is at risk, but what if the Senate does not go Republican? I think that could end up being a surprise that Wall Street did not expect, and thus, throw it for an additional loop.
Also, if deflation becomes a concern, not only in Europe but also in the U.S., it creates problems as well. So maybe the Fed stays on hold. They won’t be raising rates, but rates are so low that there’s not much more that they could do to fight deflation.
EQ: During the last few days of the market’s action, there’s been a consistent fade lower at the final hour of the trading day, which is somewhat reminiscent of when the market was going through more turbulent times. Is that something that investors should be aware of?
Stovall: The average investor, myself included, is not going to be day trading. So I don’t really necessarily need to try to get ahead of some of these half-day trading trends. I’m not surprised people end up buying into the market mid-day and then selling by the close. Very few people want to be long and exposed to additional risks that stocks could offer in the overnight session if more news happens to come out.
So basically risk is definitely on to the point where people are not willing to carry very hefty long exposures overnight.
EQ: You’ve said multiple times and reiterated in this week’s Sector Watch that investors should use the correction as a buying opportunity. What are some indicators that you’d suggest they track as buying signals?
Stovall: First off, investors need to realize that more than 85% of all declines of 5% or more do not go beyond the 20% decline threshold. So probabilities would indicate that they may want to start nibbling at these 5%, 10%, 15% decline thresholds, mainly because the bulk of these declines end up turning around before hitting 10%, and an even greater percentage don’t go much beyond the 15 to 20% levels.
Second, usually prices lead fundamentals. This is definitely a technically driven market at this point because the fundamental foundation remains solid. Earnings are coming out quite nicely for the just-completed third quarter, but prices could be indicating that future earnings could be in jeopardy. So I think we need to look for retracement levels, more specifically Fibonacci Retracement levels and prior support levels.
Right now, I would say 1800-1810 is an area that the market might possibly dip into before turning around. Certainly, the price action of Oct. 15 does appear to me to be a traditional capitulation day where everybody is throwing out everything, including the baby with the bathwater.
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