Each week, we tap the insight of Sam Stovall, Chief Investment Strategist, CFRA, for his perspective on the current market.
EQ: Both houses of Congress passed the new tax legislation, and the bill is just awaiting President Trump to sign. Yet, the market has been largely flat this week. Have investors already moved on to a new focus?
Stovall: I think that the investors’ new focus will be on how S&P 500 corporate profits estimates will be revised. Right now, we project that the current estimate of $144 per share for 2018 will likely rise to at least $155 per share, which would support our 2800 year-end target. At the time when we set that target, it represented about a 6.5% price appreciation. So, I don’t think that the benefit from tax reform has fully run its course because investors now want to find out how it will play out in terms of earnings estimates and whether the P/E ratios, which are quite elevated, end up coming back to earth.
EQ: Speaking Congress, they do also have a spending bill that needs to be voted on to avoid a government shutdown. Does this pose a risk of throwing the market off course?
Stovall: It could, but I think maybe it just causes the market to stall. Government shutdowns in the past have not led to sharp market declines. A lot of times, because the shutdown is initiated over weekends, it doesn’t have much of an effect on the overall market.
Going back to 1981, we’ve found on the actual day of the shutdown, the market fell 0.1% on average, and the bottom occurred at only a 1% decline over the span of three days. However, it took us about a week in order to get back to break-even. So, really at best, it’s a short-term annoyance and not something that investors really have to worry about.
EQ: You mentioned recently of a concern that the market has already borrowed from the Santa Claus rally. Considering the old Wall Street adage, “If Santa Claus should fail to call, bears may come to Broad and Wall.” Is this something to bear in mind, or would this year be somewhat of an exception?
Stovall: Well, even if we were to sort of tread water between now and the end of the year, I don’t think that it will be regarded as Santa failing to call. Let’s face it, the market has been up already in December in anticipation of tax cuts and other factors. Also, realize that we’ve had more than 60 new all-time highs set this year, yet fewer than 10 days in which the market rose or fell by 1%, and usually, that means the next year is positive. Unfortunately, it’s positive by only 5% and the frequency of advance has been less than normal at 60% rather than a number that’s closer to 75%. So, I think the outlook for 2018 probably has more to do with the entire year of 2017 than it does the final few trading days of the calendar year.
EQ: In our previous interview, we discussed briefly about investors allocating a portion of their portfolio into foreign stocks. In this week’s Sector Watch, you did a bit of a deep dive into various markets and their outlook. Is 2018 the year international equity markets play some catchup to its US counterpart?
Stovall: Actually, the international areas have done exceptionally well. Through the middle of December, on a total return basis, emerging markets are up by 27% and developed international markets are up 23%. Both of them outpaced the S&P 500’s sub-22% advance. So, you could say that investors have already shown interest in gravitating toward overseas. But I think also if we look from a more top-line perspective, we find that economic growth is expected to be stronger outside US shores than within. Our estimate is for a 3.9% year-on-year gain in real GDP globally, versus a 3.0% advance in the US. So, stronger growth overseas—granted much of that growth will be concentrated in the emerging markets—but our feeling is that since about 50% of the revenues from the S&P 500 comes from overseas operations, if global economies improve, that will benefit the companies located here in the US as well.
EQ: Which markets in particular should investors be considering when looking overseas?
Stovall: That question is asked of me every so often during presentations, and what I like to do is reference the CFRA research that we do on ETFs. We apply our qualitative buy, hold and sell ranking to each of the stocks within those particular ETFs, along with their quantitatively derived buy, hold and sell recommendations. Adding to that, our technical evaluations, plus other factors, such as risk measures, standard deviation and costs. What I then do is look at broad benchmarks, as well as country ETFs to serve as proxies for whether we think investors should overweight, marketweight or underweight those areas.
Right now, we have overweight recommendations on the emerging markets, emerging market small caps, and on the BRIC countries. We have neutral recommendations on the developed markets and international small caps. Looking overseas, we have positive recommendations on Canada, Italy, Switzerland and Turkey, and in the Asia-Pacific area, we have China, South Korea and Taiwan. Areas where we have underweight recommendations, particularly is found in India. Basically, an investor can take a look at these ETF reports and get a pretty good idea as to which areas have favorable investment implications versus other single countries or markets.
EQ: How can investors access these reports?
Stovall: They can go to http://trymsatoday.com/ and sign up for a free trial.