Each week, we tap the insight of Sam Stovall, Chief Equity Strategist for S&P Capital IQ, for his perspective on the current market.
For more from S&P Capital IQ, be sure to visit www.getmarketscope.com.
EQ: The S&P 500 has fallen over 5 percent from its high of 1848 on January 15. Are we officially in pullback mode? What is the likelihood we could slide into a correction from here?
Stovall: We are in pullback mode because, on a closing basis, the S&P 500 has declined by 5 percent or more. Of course, there is no universally accepted definition for pullbacks, corrections, bear markets, etc. But we define a pullback as a decline of 5 to 9.99 percent; a correction as a decline of 10 to 19.99 percent; and a bear market as anything worse than 20 percent. If you want to take it one step further, you could break the bear markets into categories of garden-variety bear markets, which are declines of 20 to 39 percent, and mega meltdowns, which are 40 percent or deeper.
We’ve had 12 bear markets since World War II, and nine have been garden variety, and three have been mega meltdowns. We’ve had 19 corrections, and have had 57 completed pullbacks. I say it that way because I don’t know if this current decline will end as pullback, or morph into something deeper.
EQ: Based on what we know about the January barometer, what can we expect from the S&P 500 for the rest of the year?
Stovall: When the January barometer is down, it adds to the already high level of uncertainty for investors. The Stock Trader’s Almanac was the first to introduce the January barometer to me. It says that, going back to 1945, whenever the S&P 500 was up in January, it continued to rise for the remaining 11 months of the year about 85 percent of the time. The average gain was 11.5 percent for these observations.
Whenever the market was down in January, the average 11-month price change was a gain of 0.1 percent. But we had pretty much a coin flip for whether the market was going to be up or down, because the market ended higher 56 percent of the time versus ending with a decline 44 percent of the time.
So I would tend to say that at best, a down January indicates that investors are going to have a rocky ride and are going to be wrought with uncertainty.
EQ: You discussed in this week’s Sector Watch that the January barometer is surprisingly accurate, even if we dig deeper into the sub-industries. You actually established a portfolio based on your findings. Can you discuss the method in building this portfolio?
Stovall: Thinking that the market’s performance in January gave us a good indication of what was going to happen the rest of the year, I wanted to see if I could create a portfolio of sub-industries based on those that did the best.
I found that since 1990—which is as far back as S&P Dow Jones Indices has sub-industry level data—if you purchased the best-performing sub-industries on Feb. 1, based on their January performance and then held them until the end of January of the subsequent year, the compound rate of growth was 13.3 percent for those 10 best sub-industries versus the 9.5 percent for the S&P 500.
Incidentally, the worst-performing sub-industries gained only 5.8 percent. So if investors are thinking they’re better off buying those that were beaten up in January, history does not agree with that philosophy.
EQ: Should investors rotate into these industry leaders, hold steady, or a combination of both?
Stovall: If you wanted to embrace the January barometer portfolio, I would say that you have to do it at the beginning of February because that’s how the performances have been measured. If you believe the markets are going to continue to go down, and you want to try to get a better price, that’s up to you.
Last year, the 10 best-performing sub-industries gained about 32 percent from January to January versus 19 percent for the S&P 500. On Standard & Poor’s MarketScope.com, I show the 10 stocks that serve as proxies for the 10 sub-industries that one could buy and hold for the coming 12-month period.
Health Care, Information Technology, and Utilities were the three best-performing sectors, according to the January barometer, and we see that they are relatively defensive in nature. I think what it’s basically saying is to go to your traditional defensive areas of Health Care and Utilities. If you want to lean slightly cyclical, then you can go to a group that has been recently beaten up in Information Technology, which ended up having a good start to the year.
That said, I think investors do realize that the market is trying to find its footing. We probably will see some sort of a counter-trend rally, but we might find that the decline does end up going beyond the 10-percent threshold to become a correction. If that’s the case, corrections usually take about five months to unfold, and then four months to get back to break-even. So overall, it could be a challenging nine months.
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