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 Fed minutes from October’s meeting showed concerns about inflation remaining low for a prolonged period of time. Yet, the timeline for rate hikes remained the same. Why did the market respond positively to the news?
Stovall: I think that the reason investors felt a little heartened by the recent FOMC minutes is because there really is no need to be raising rates dramatically anytime soon. What the Fed wants to do, I think, is to get back to normal rather than to just try and slow the economy.
Right now, the Fed does not have many arrows left in its quiver. By bringing the Fed funds rate to a more normal level compared with inflation and longer-term rates, it would make them feel a little bit better to have something that they could use later on should the economy start to slide once again. With inflation being fairly low, I think investors are betting that the Fed will begin raising rates later rather than sooner, meaning probably in the latter part of the third quarter instead of the end of the second quarter.
EQ: In last week’s IPC notes, you suggested that underperforming fund managers will likely help the market’s upward bias as they play catchup. Can you elaborate on that effect?
Stovall: Using S&P’s MarketScope Advisor platform, I noticed about 73% of the large-cap value-oriented active managers were underperforming the S&P 500 value index. Even worse, about 95% of the large-cap growth managers were underperforming their benchmark. My feeling was that these managers are not likely to cash in their holdings and take the rest of the year off due to their performance so far.
I think these fund managers want to earn their bonuses, and as a result, will probably engage a little bit of a style-drift to up the octane and hope to see an improvement in their overall return, which could help get them either closer to or beyond their benchmarks to make it a good year for them.
EQ: Do these fund managers usually rotate into the winning stocks, similar to the window-dressing effect?
Stovall: That is a good question, but I can’t really say specifically where they will rotate. However, on a short-term basis like this—since we’re really only talking about a month and a half—you’re probably better off looking for those stocks that don’t have a lot of overhead resistance. By that, I mean not the stocks where owners purchased them at higher prices and are therefore waiting to sell out once they get back to break-even. But usually, momentum players tend to do relatively well in a short period of time.
EQ: In this week’s Sector Watch report, you focused on the homebuilders sub-industry group, which has actually gained over 18% since mid-October in the form of the iShares US Home Construction ETF (ITB). Why is this an important group to watch at this time?
Stovall: I think homebuilders is an important group because, first off, I find that housing starts are very important when gauging the likelihood of recession. Seven of the last eight recessions since 1960 were preceded by 30% declines in housing starts. That decline is on a year-over-year basis. Right now, we’re looking at housing starts that are up by double digits on a year-over-year basis. So I don’t see a recession around the corner, at least not one being indicated by housing starts.
I also believe that home building is important because it’s an indication of economic growth, and also of consumer confidence toward not only their jobs but also in their ability to be able to own an important asset such as a home.
So homebuilding stocks have started to improve. They’ve come off the very low base that they had as of the second quarter of this year and are beginning to look stronger once again. My feeling is, because of lower energy prices, improving consumer confidence, an unemployment rate that’s below 6% and wage gains that are above the rate of inflation, in general consumers now have the wind at their backs.
EQ: The market tends to have a historical upward bias in the final months of the year. Are there any potential obstacles from here until the end of the year that investors should keep an eye on?
Stovall: I think there is one concern. We’re seeing a repeat of what happened in the first quarter of 2014, and that’s the polar vortex and significant snowfall. So the worry is whether we could have this polar vortex cause a problem for the remainder of this fourth quarter and end the year on a down note. That’s the concern.
If we find that, because of snowfall, people can’t get to work, it could have a negative impact on employment trends and the ability for consumers to have disposable income, especially if they are hourly workers. So I’m just hoping that we don’t end up seeing the polar vortex become a headwind the way it was last time.
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