Each week, we tap the insight of Sam Stovall, Chief Investment Strategist, CFRA, for his perspective on the current market.
EQ: The S&P 500 experienced its worst Christmas Eve in history, falling to the edge of a bear market on a closing basis Monday. On Wednesday, however, stocks rallied in a major way. What are your thoughts on the market’s pre- and post-Christmas activity?
Stovall: With the pre-Christmas activity, you had a shortened trading day and carryover of negative sentiment from the week before in which the S&P 500 suffered a major decline. You also had comments from Treasury Secretary Steve Mnuchin that raised a lot of red flags—Why is he reaching out to the banks to ensure liquidity? What does the government know that we don’t know?
And so, realizing that the market would be closed for a day and a half, I think investors decided to sell first and ask questions later. As a result, we got into a very oversold condition that I think made for the opportunity for opportunists to come in and buy up some shares, at least in the near term. Also, because we did not have a continued round of comments from the Treasury Secretary, I think investors concluded that their worry on Monday was for naught.
EQ: With regards to Mnuchin’s comments, is this a case of market overreaction or could it be scenario in which where there’s smoke, there’s fire?
Stovall: Well, I think that investors are reminded that prices lead fundamentals, so they always worry that when there is smoke, eventually fire will break out. But the economy of the US and the globe are not expected to be slipping into recession, so I think this ends up being a very deep correction that could last for a while as we recover from it and then retest this low.
I think right now investors are going through, maybe not an economic recession nor an earnings recession, but certainly a recession in confidence. Confidence as it relates to leadership out of Washington from both the Executive and Legislative branches, as well as confidence that the economy will hold up in the face of this global trade war. So, investors have a lot to worry about. But I think the question is, how much could go wrong? If all of this negative news is already built into share prices, then it could end up being a positive for the market.
EQ: In this week’s Sector Watch, you pointed out that since 1995, there have been 15 times in which the market fell below 5% but only once did it confirm a bear market after falling this low. Was that the type of capitulation the market needed to go through to resume an uptrend or do you think something has broken here, either from a technical or fundamental standpoint?
Stovall: The market definitely needed to go through a capitulation before it could wring off the loose hands and allow the market to stage at least a near-term rally. With only one 1% of the 146 sub-industries in the S&P 1500 still trading above their 10-week moving average, that really was a sign of negative excess in my opinion.
Of those 15 times, only one of those periods did we eventually slip into a bear market. The 14 other times ended up being corrections that turned around before closing more than 20% below the previous high. So, maybe this will end up being 15 of 16 times in which a correction ensued but a bear market did not, and maybe this was the capitulation we were looking for.
EQ: Considering how close we are to that bear market threshold for the S&P 500, from an investor’s standpoint, should their approach be differentiated whether this ends up being a very deep correction versus a shallow bear market?
Stovall: There really is no difference. I think the reason that people differentiate between a correction or a garden-variety bear market (20-40% decline) has to do more with the speed with which it takes to get back to break-even. Normally, it takes about four months for the S&P 500 to get back to break-even following corrections of 10-20%. Back in 2011, when the S&P 500 fell 19.4%, we got back to break-even fewer than five months later. You could say it took us longer than it normally does.
Garden-variety bear markets, on the other hand, take about 14 months to get back to break-even because so much damage has been done, not only for the technicals but for investor confidence. Humans are compartmentalizers; hence we look to pullbacks, corrections, garden-variety bear markets and mega meltdowns. But at the same time, it’s the percentage and time it takes to get back to break-even that causes us to want to compartmentalize these sell-offs.