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 continues to climb higher as the GOP tax plan pushes forward. Does this set the market up well for the Santa Claus rally?
Stovall: Well, the concern that I have is that we could be seeing the Santa Claus rally occur earlier in the month. The real question is whether the tax plan makes its way through Congress, and whether the Senate and the House can agree on a final version. From there, the question then comes down to whether the old adage of “buy on rumor, sell on fact” steps into play.
I think there is still some upside potential, but that the angle of accent is likely to come down a little bit, and while we will end up with a Santa Claus rally, maybe it’s not as great as some people will be anticipating.
EQ: There are a few potential red flags also emanating from Washington investors may need to watch closely. With the Mueller investigation probing deeper and Congress negotiating to avoid a government shutdown by Friday, could this threaten the market’s run here?
Stovall: Well, there is something called the mid-December low, where we do tend to have weakness in the overall market toward the middle of the month. It’s usually when investors start to unload shares that have not worked out for them during the year and start thinking about positioning themselves for the year ahead. So, I wouldn’t be surprised if we have the mid-December low, maybe not triggered but at least encouraged by the worries coming out of Washington.
But I don’t think it will keep the market down for long because I don’t see those headlines affecting the bottom lines, and I don’t see it causing us to fall into recession. Should we get no tax bill at all, then yes, I think the market is overvalued and could decline anywhere from 10% to 15%, but I don’t think we’re heading for recession. As a result, I don’t think we’ll be falling into a new bear market.
EQ: In this week’s Sector Watch, you looked at a number of consumer confidence indicators. How confident is the consumer right now?
Stovall: Right now, the consumer is very confident. Whether you look at the Conference Board’s US consumer confidence index, the University of Michigan’s Consumer Sentiment index, or the Bloomberg index, they’re all pretty much at or near highs. So, what’s interesting is, the only reason a consumer would feel optimistic is if they have a job or feel that they will soon be having a new job, and they’re not worried about losing that job. So, essentially, they’re feel as if things are essentially going their way.
EQ: There seems to be a few ways strong consumer sentiment can be perceived from an investor’s perspective. Some see it as a positive indicator while others as a contrarian signal. What has history shown to be the better use for this?
Stovall: I did find that using consumer confidence as a contrary indicator has really not been a very good way to go. Since the late 1970s, when the University of Michigan index was first created, if you purchased the S&P 500 whenever that indicator rose above one standard deviation from the mean—implying an excessive level of confidence—the market actually continued to rise in the coming three and six months by an average of about 2.5% and 6.5%, respectively. The frequency of the market going up was about 62% in the first three months, and about 67% in the six-month period. So, it really does not end up being a very good contrary indicator.
EQ: Keeping that in mind, we’ve discussed the outperformance of momentum investing throughout this bull run. Based on your findings regarding consumer sentiment, should investors continue to stick with momentum investing here?
Stovall: Well, first off, I think they have to look inwardly. I like to say that in order to have fun, you have to be at the amusement park. Likewise, in order to earn a return, you have to be in the stock market. But you get to decide if you want to be on the rollercoaster or on the Merry-go-Round. If you have no problem being on the rollercoaster, then a momentum-based approach could work just fine.
My industry momentum portfolio essentially looks at those sub-industries that are in the top 10% on a trailing 12-month basis, and then I choose a stock to serve as a proxy for each of these sub-industries based on CFRA equity analysts’ recommendations. So, if you do have the stomach to weather increased volatility, which is definitely something a high-momentum approach will deliver, then I would say by all means go ahead and embrace it—not for your entire portfolio, but a portion of it.