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Each week, we tap the insight of Sam Stovall, Chief Investment Strategist, CFRA, for his perspective on the current market.
EQ: Lawmakers are expected to release a draft of the tax reform bill this week. What do you think investors are hoping to see in this draft?
Stovall: In general, I think investors are hoping that they see something that will be embraced by at least a majority of Republicans in order to pass the bill. However, preferably there will be acceptance on a bipartisan basis so that it has a much greater chance of working its way, not only through the House, but also through the Senate. I think investors are just looking for something that will be easy to approve.
Second, I think investors are hoping that we’ll see a meaningful decline in the tax rate because it has been estimated every 1 percentage point reduction in the tax rate will push up S&P 500 corporate earnings.
EQ: The latest Fed statement came out Wednesday, and all indications point to a December rate hike still on track. In your opinion, were there any key takeaways, particularly as a replacement for Fed Chair Janet Yellen is expected to be named Thursday?
Stovall: The biggest concern that I saw was that the inflation rate continues to hover below the desired level by the Fed. If you recall, the Fed did not raise rates in the past when we had inflation that remained well below the 2% threshold. I believe that the Fed will raise rates when they meet in December, but instead of raising rates three times in 2018, they may end up only doing it twice should the rate of inflation remain subdued.
As for the potential replacement for Fed Chair Yellen, even if we get somebody who appears to be more hawkish, we are still in a very stimulative environment because the rate of inflation remains more than 50 basis points above the Fed funds rate.
EQ: The November marks the official start of the Cyclical Six period, and in this week’s Sector Watch, you laid out the strong track record of rotating into cyclical sectors for the coming six months. This isn’t just for the S&P 500, but for stocks of all sizes. How pervasive was this trend for the various market cap sizes?
Stovall: It was very pervasive. From an average percent change basis, the November through April period since the inception of the S&P Cap-Weighted 500, Equal-Weight 500, MidCap 400, SmallCap 600 and Global 1200 posted its highest six-month return during this period. In more cases than not, they also recorded their highest frequency of positive returns. Whenever we didn’t have the highest reading in that November through April period, it did end up being the second highest six-month reading.
EQ: The S&P 500 performed considerably better in the sell in May period this year than its historical average. How should investors take this into account for the coming Cyclical Six?
Stovall: I think investors need to be reminded that this is not that rare of an occurrence. Even though the S&P 500 has gained only 1.4% on average from May through October, it was up more than 5% this year, as well as 26 other times since World War II. Rather than thinking the May through October strength has now borrowed from the November through April potential, history would remind us that it’s actually served more like a running start for the coming Cyclical Six in that the average price change was 8.2% rather than the more normal 6.7%. The batting average also increased with the market rising 85% of the time in the November through April period following strong May through Octobers rather than the long-term average of 76%.
EQ: How should investors implement this strategy? Is it too late to do so now if they haven’t already?
Stovall: I don’t think it’s too late to start now, because if the average price gain has been close to 7%, and we haven’t seen that yet. Should the average be replicated this time around—and there’s no guarantee that it will—I think that it still implies that there is ample time for investors to do this. Just as you should rotate and not retreat in the May through October period, you also want to be focusing on the cyclical sectors in the November through April period.