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: In this week’s Sector Watch, you looked at the outlook for the second half of 2014. Did it seem like the market and the economy cruised right through the first half?
Stovall: Well, I wouldn’t use the term “cruising through” because that would imply that we had very few ripples and very little reason to be concerned about what has been going on. We did endure a near-6% decline earlier in the year on concerns about emerging markets and concerns about small-caps and momentum stocks, especially in response to Fed Chair Yellen’s commentary implying that maybe interest rates will start to rise more quickly than Wall Street had anticipated. I think that comment, in a sense, threw investors in for a loop.
EQ: What were some of the biggest surprises that we’ve had so far, in your opinion?
Stovall: I would say that the market itself surprised investors. Among the biggest surprises that I saw was the decline on the yield of the 10-year note. Heading into 2013, the yield had peeked its head above 3% and I think most on Wall Street thought we’d continue to work our way up to between 3.5% and 4%. But in fact, we went down and retested an important level at 2.4%.
I think that happened for a variety of reason. It could have been because of rebalancing, or concern about the health of the U.S. economy, or because the 10-year note is a global bond. We had a lot of international investors who were looking to the U.S. as a flight to safety, but also a higher yield as compared with what they might be getting elsewhere.
EQ: The Standard & Poor’s IPC has a 12-month target of 2100. Do you forecast a similar environment going forward or should investors expect changes?
Stovall: I think things will change. Our belief is that the yield on the 10-year note will go up and challenge, then surpass the 3% level. While we ended up with a first-quarter decline in GDP of close to 3%, our expectation is that when the second quarter data comes out on July 30, we’ll get an idea that it’s going to be closer to 3.5% or even higher. And for the second half of 2014, we would see GDP growth in excess of 3%. That would certainly be GDP growth that is much better than expected.
Also, while we did not have a market correction in the first six months of this year, I wouldn’t be all that willing to assume that we won’t have a correction in the next six months of the year. We’ve now gone 33 months without a decline of 10% or more, and the median is 12 months. So it’s just a matter of time, in my opinion, and a correction is something we probably will have to endure in the coming six-month period.
EQ: It does seem like that as this bull market gets older, it becomes increasingly more stubborn. The second quarter of a mid-term election year is historically the weakest of the four-year cycle. Aside from a 4% dip in April, investors have to be pretty happy with how the S&P 500 performed in Q2. What were some of the reasons why the market bucked the historical trend?
Stovall: I think because we really didn’t come up with any new things to worry about, or at least not enough to worry to the point where we were thrown into a tailspin. Earnings are still coming in at the mid-single digit area. Valuations are equal to long-term averages, and not excessively above them.
Yes, we had tensions in the Middle East, but we always seem to have tensions in the Middle East, and while it appears as if the tension between Russia and Ukraine was going to spill over with tanks crossing the border, those tanks ended up pulling back and take us from the brink of some sort of military action. So I think in general, investors were still thinking that stocks are the better place to be. You can get higher yields on stocks than you do on bonds. You also get capital appreciation potential on stocks, and stocks usually hold up relatively well in a rising interest rate environment. So a lack of alternatives combined with a lack of reasons not to invest in stocks, I think, allowed prices to move higher.
If I could add one more thing, it would be that while a lot of behaviorists say that stock movements occur because of fear and greed, I would actually say that it’s actually just fear. It’s fear of losing money on the way down, or in this case, the fear of missing out on the way up. I think that’s what investors are doing now. They are fearful of missing out on this bull market’s run.
EQ: The S&P 500 is within striking distance of the 2000 threshold. Do you anticipate some volatility and possibly a pullback or correction before that?
Stovall: I sort of feel like we were talking about this at the 1900 level. Back in the April timeframe, I said we usually end up treating century marks and millennium marks as levels that act like rusty doors. They usually require several attempts before they finally break open. So I think 2000 will be no different than 1900, and it probably will end up being a more formidable resistance for investors to break through.
So maybe 2000 could end up being a level beyond which the market will not be able to exceed prior to having a more meaningful give-back in prices.
EQ: If that does end up happening, what are some potential triggers?
Stovall: In terms of triggers, many times it ends up being an unanticipated event. Other times, it’s events that were underestimated. Right now, the big concern is Europe is really not acting as well as some investors would like. Economic growth will probably be weak for the second quarter, and probably weak for the second half as well.
Here in the U.S., I think the big worry is how quickly inflation starts to heat up.
Then in other parts of the globe, the question points more to military activity and more importantly, the curtailing of shipments of important commodities and natural resources. So we could end up with a variety of things that could trigger a decline but I think seasonally, even something as mundane as an even number on an index could be reasons enough for resistance.
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