Each week, we tap the insight of Sam Stovall, Chief Investment Strategist, CFRA, for his perspective on the current market.
EQ: On Wednesday, economic data showed that inflation for January rose higher than expected while consumer spending came in below expectations. The market seemed to take that news in stride, however. From a market perspective, is this an encouraging sign that we may have seen the worst of the recent correction?
Stovall: I think so. I would’ve expected the market to give back some of the recent rally because both inflationary measures—the headline and core CPI data—came in stronger than expected. Since inflation seems to be investors’ big worry because it could have on the Fed’s rate tightening timetable, I was encouraged that share prices rose despite that. Possibly it’s because retail sales came in weaker than expected, and the belief therefore is that while inflation might have picked up a bit in the most recent month, we’re actually seeing the consumer spending pullback a little bit. That could end up being more important in the long run for the decision whether the Fed hikes three or four times in 2018.
EQ: Market prognosticators are saying that the latest core CPI figures all but locks in a March rate hike and increases the likelihood that the Fed will have to hike four times this year instead of three. For a while now, we’ve discussed how the Fed has done a good job becoming predictable. Could that be changing here as economic factors shift on them?
Stovall: Well, I think it would probably not have an effect on the upcoming March 20-21 meeting, where a 25-basis point hike has pretty much been priced in. It’s also going to be the first meeting under Fed Chair Jerome Powell’s guidance. The real question is, what does it mean for future rate increases?
Right now, the Fed funds futures are pointing to a 75% likelihood of an additional rate hike by the July meeting, as well as a possible third tightening in the third quarter. But there’s only about a 30% chance that we see a fourth tightening by the end of the year. Right now, I would say that three are in the bag, and it is sort of a wait-and-see on the fourth.
EQ: In this week’s Sector Watch, you looked at the movement of the S&P 500 during the current correction. You noted that it hit pullback and correction levels much quicker than the historical averages. What does that tell us about this market and the potential implications of its recovery?
Stovall: When you put it into perspective, you realize this really was a rapid decline. The S&P 500 eclipsed the -10% threshold in only 13 calendar days, which is the quickest time since World War II for any decline of 10% or more—regardless of whether it ends up staying in correction zone or actually goes into a bear-market mode. Normally, we end up seeing a median of 64 days to go from peak to the 10% correction level.
So, what I found was that if you were shorter than that median, then instead of taking a total of 98 days to bottom, it took only 38 days for the S&P 500 to go from the peak to the trough. Based on how trading has been going over the last day or so, maybe this one will be setting a record as well.
In terms of the number of days to fully recover from the loss, on average it takes about 84 days for that to occur, but again, it ends up being about 13 days shorter whenever we’ve had a very quick sell-off. So, like ripping a Band-Aid, it serves as a shock, but ends up being over much quicker than the average.
EQ: You also identified which areas of the market investors may want to look to if they wanted to play the recovery. What sectors and industries could be poised to outperform here?
Stovall: I call them the Dirty Dozen because the 12 sub-industries that are beaten up the most during a market decline tend to be the leaders coming out of that decline. Going back to 1990, the S&P 500 in the six months after corrections and bear markets gained about 22%. If you had purchased the three sectors that had fallen the most in that correction and then held them for six months, you got a 24% rise. Yet, if you bought the 12-worst performing sub-industries, you ended up more than doubling the return of the S&P 500.
Of course, that’s not a guarantee, and it did not work all the time, but it did tend to outperform the market about two out of every three times. These are a variety of companies and sub-industries that did quite poorly, and if history holds, will be the leaders during this recovery.