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 S&P 500 was uncharacteristically down in April, which is historically the second-best performing month of the year. What were some issues that weighed on the market?
Stovall: I think heading into April, a lot of investors were concerned that stock prices had gone too far, too fast. The S&P 500 had gained more than 11 percent in both the first quarter of this year and the fourth quarter of last year. So even though history says that the market traditionally maintains its momentum heading into April, obviously history is a guide and never gospel. Also, investors continue to be concerned about the ongoing sovereign debt overhang in Europe, the weaker than expected GDP report coming out of China, and that the U.S. economy is slowing once again as it did this time last year and the year before.
EQ: Do you think April's decline could have any bearing on the "Sell in May and go away" adage?
Stovall: I don’t necessarily think April’s decline could have a bearing on the old adage. However, I do believe that with so many investors expecting the market to decline this year the way it did last year and the year before, it makes me wonder if we whether we’ll have a decline at all, or if we do, possibly it will be delayed and become the “Swoon in June.” May, as a month on its own, is an unspectacular month. Since World War II, the S&P 500 performance has been half of what we’ve seen in all 12 months, on average. Yet there have been times we’ve had very good results in May, such as when the S&P 500 was up 9.2 percent in the May of 1990. But on average, the performance has been relatively lackluster, placing May eighth of twelve in terms of the best performing months.
But the old adage of sell in May and go away is one I don’t think should be adhered to anyway because the average price change for the S&P 500 from May through October has been substantially better than what you’d get in the money market. Besides, I have found that if an investor gravitated toward the defensive sectors—Consumer Staples and Healthcare—from May through October, they would have been able to add 4 percentage points to their annual returns since 1990, knowing of course, that past performance is no guarantee of future results.
EQ: Judging by the recent performance of some of the sector ETFs, investors have already been rotating into more defensive sectors. But one group that you caution is healthcare. Why is that?
Stovall: For this year, the big overhang of concern is the judicial review of the Health Care Reform law, which was passed a couple of years ago that requires uninsured people to get insurance. It is getting reviewed by the Supreme Court and one of three options could result. The Supreme Court could uphold the initiative, which I think the current administration and investors of Healthcare stocks would prefer because then there’s not going to be any undue unraveling of the current law, which a lot of companies have already begun to operate under. The second best scenario would be that the law was struck down entirely, even though that in itself could be a bit challenging because some companies have already started paying taxes into that healthcare plan. The worst-case scenario would be if their requirement to purchase insurance was the only thing that was struck down. It would be very challenging because it would leave many factors of the Healthcare Reform Law in place, and to undo one law and not undo the rest would be akin to trying to unscramble an egg.
EQ: For at least a few months, investors have been able to put Europe out of their minds. Now that earnings are winding down, and the economic downturn in Europe retakes the spotlight, could the U.S. markets be at risk of a more serious move lower?
Stovall: Yes, they could be at risk of a more serious move lower, but every time that the market appears to be or has reason to move lower, it tends to show resiliency—despite the seasonals, despite the sentiment, and despite a couple of worse-than-expected economic reports. So as a result, I’m calling this a “median market” because the trailing 12-month price-to-earnings ratio on GAAP results is 15.7, which is exactly equal to the median since 1936. Also, what we’re finding is that the year-over-year percent increase in as-reported earnings is within 1 percentage point of the median of 8.9 since the 1930s. So as a result, this median market doesn’t look too likely to be sold on its own. I think we would require external factors like a continued weakening of global GDP growth rates or a spike in bond yields to blow this stock market off its course.
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