As Sam Sees It: Where Do Stocks Go From Here?

Sam Stovall |

Sam Stovall Chief Equity Strategist for S&P Capital IQEach 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 S&P 500 has broken through its five-year high to start 2013, which in of itself is encouraging for bullish investors. But how optimistic should investors be based on the fact that this has occurred during a secular bear market?

Stovall: Actually, it’s a relatively unique thing to have happened in that we’ve established a five-year high but are still below the prior bull market high. In other words, this new five-year high has happened while the market is remaining in a secular bear market. That has only happened five times in history: 1936, 1943, 1978, 2006, and now. So it’s a fairly rare thing, and the reason for that is the speed with which the market tends to snap back from a bear market requires an average of 44 months to eclipse the prior bull market high, and actually if you take out the crash of 1929, the average is 28 months. In 10 of these 15 bear markets, it’s taken fewer than three years. So to be five years beyond the prior bull market peak and still be in the confines of a secular bear market is a very rare situation.

Taking that one step further, a lot of investors then ask where the market could be 12 months from here now that we have established a five-year high. Looking at these limited numbers of observations and following the recovery highs of these prior four times, the S&P 500 posted a 12-month price increase of 11.4 percent on average. Also, all four of those observations saw the market higher 12 months later. So if the S&P 500 price performance in the coming year mimic that of history, and there’s no guarantee it will, the market could be trading more than 11 percent higher—up toward the 1630 level—by early January 2014.

EQ: You pointed out that investors returned to the stock market in a big way during the first week of 2013. As investors ready to re-enter stocks now?

Stovall: We saw an $18 billion increase in the amount of money flowing into equity mutual funds for the week ended January 9, which is more than any week in all of 2012. This is actually a very positive bit of news. However, it really is just the first time we’ve seen any kind of a reversal of the trend where money had been flowing out of equity mutual funds and heading into fixed-income mutual funds. What I thought was interesting was that some bears were saying that we now have to get worried about all of this money flowing into equities because the market usually is a better contrary indicator and retail investors are now heading back toward equities. So they believe maybe it’s time to lighten up.

It’s interesting that only one week’s flow would cause people to worry about too many retail investors being in the equity market when they’ve been moving out of equities since 2008. This market would have to see an awful lot more of inflows in order for me to feel uncomfortable with how investors are once again warming up to equities.

EQ: Is this an example of being a contrarian just for the sake of being contrarian?

Stovall: It could be that, or it’s simply because some investors are convinced that the next move in the market is going to be lower and they are going to reach for any bit of data or news that will help explain their story.

EQ: Could another debt ceiling debacle derail this positive trend for stocks?

Stovall: Yes, it could. Right now, most investors don’t believe that it will because they’ve come to realize that Congress is more bark than bite. While there’s an awful lot of drama surrounding these negotiations, Congress realizes it has to pay our bills and not threaten the debt ratings and the quality of our debt as it is perceived by global investors. So, again, I think the Republicans will try to squeeze whatever cost cuts they can out of the Democrats. There will be a lot of heated rhetoric back and forth, but in the end, we think they will end up with some spending cuts to help undo the sequester and we will raise the debt ceiling. That could actually prove to be a fairly positive situation for equities and could help to push them above the 1500 level.

EQ: Would investors be better suited to take a more conservative approach over the next month or two Congress works through both the debt ceiling and spending cuts deadlines, as well as possible profit-taking from investors?

Stovall: Even though the market has grudgingly crept higher since June 2012, we’ve only recently really been able to benefit from the fiscal cliff agreement that had been made on January 1. So I would tend to say that history points to the remainder of January to likely be good for equities. At the same time, February is traditionally the second worst-performing month for the market, behind only September, where the average price change is negative and the most frequent movement in the market is down rather than up.

Since 1945, we’ve had 75 times that the market has either experienced a pullback (5 to 10 percent decline) or a correction (10 to 20 percent decline). Those things happen basically once a year, so I would not be surprised if we had a digestion of gains—something probably in the order of a 5 to 10 percent decline. However, in my opinion, based on global economic growth, projections based on earnings growth trends, and other factors, investors would be better off buying than bailing.

EQ: So this actually creates buying opportunities for investors, would you agree?

Stovall: Yes, I would. Last year, we were very lucky because we had very low volatility. Only three times in 2012 did the market post a one-day decline of 2 percent or more, versus the 21 times in 2011, and an average of 15 times per year going back to 2000. Volatility is a normal event in the equity market and investors have to realize that. However, I believe valuations still look relatively attractive, pointing to being undervalued by anywhere from 10 to 15 percent or even more. That applies whether you look to trailing or projected operating earnings. This would imply to me that we probably will see some declines in the market and there could even be a time where the market closes at a level that is below the 2012 closing level, but I still would look upon that as a buying opportunity and not as a reason to panic all over again.

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to: http://www.equities.com/disclaimer

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