Each week, we tap the insight of Sam Stovall, Chief Investment Strategist, CFRA, for his perspective on the current market.
EQ: President Trump disbanded his business advisory councils after a number of CEOs resigned amid the handling of the Charlottesville protests. What kind of implications could this have on the economy and market, if any, going forward?
Stovall: I think the implication is that the President will be losing credibility in Congress, and therefore, will not be able to push through tax reform, infrastructure spending, and other programs purely on the force of his personality. So, it will have to be something that the senators and Congresspeople will think could benefit their possibilities of getting re-elected.
Yet, the market doesn’t seem to be too concerned by all of this. It realizes that politics makes for great headlines, but it’s the economy itself that helps the bottom line. Right now, economic growth needs to be strong enough as well as on an upward trajectory to cause investors to buy into stocks even without the stimulus potentially offered by tax cuts and other changes emanating from Washington.
EQ: Minutes from the Fed’s July meeting were released on Wednesday, and it showed that the FOMC may be split the outlook on inflation. Does this add a little bit of uncertainty for the Fed’s timeline?
Stovall: I think it confirms what many analysts have already been thinking, and that is the Fed is likely done raising rates for 2017. The economy is still growing by less than 3%. Expectations are that the rate of growth will not be picking up too dramatically. Inflation is likely to stay under 2%, which is their target rate, but it’s certainly not enough to make them feel comfortable that they can raise rates and, at the same time, not slow overall economic growth. So, it seems as if the Fed is likely to be sitting on its hands for the remainder of the year.
EQ: In this week’s Sector Watch, you examined the current economic conditions to see if a bear market may be on the horizon. Were there any signs that stood out to you?
Stovall: Yes, how the economic and monetary indicators disagreed with the valuation indicators of the overall market. What I mean by that is the year-over-year percent change in GDP at 2.1% is well below the average of 3.9% seen at market tops. Unemployment rate is also not excessive relative to prior tops, nor is housing starts, the yield on the 10-year note, or the yield curve. So, those economic and monetary indicators would imply that there’s still life left in this bull market.
However, when we look at valuations, the P/E on trailing 12-month GAAP earnings is the second highest since World War II. If you include inflation, it is the third highest since WWII, and if you look at the S&P 500’s market cap to real GDP, it’s at a level that even exceeds where we were back in 2000. So, valuations do look pretty lofty at this point, and I think investors are going to feel that they need to see an improvement in earnings growth before they can push share prices dramatically higher.
EQ: Fundamentals are one thing, and sentiment can sometimes be a completely different animal. What is the current mood on Wall Street at the moment, and how does it line up to the fundamentals that you analyzed?
Stovall: Well, the current mood on Wall Street is actually pretty low in that when you listen to financial radio, watch financial TV, and read the financial press, basically every other article is talking about how a 5-10% decline is around the corner or maybe even a new bear market. Possibly that’s simply because of the old adage of “If it bleeds, it leads,” and that negative stories get more attention than positive ones, but I would tend to say that the sanguine approach that investors have toward the market is probably the only encouraging thing out there currently.
EQ: Is negative sentiment actually a positive for the market in that we’re not in an exuberant market?
Stovall: Yes, that’s absolutely right. Bull markets tend to go out with a bang, not a whimper, and it’s usually when investors are throwing caution to the wind and basically saying things like “buy, buy, buy!”, “this time it’s different,” and using all the other phrases that tend to ignore history. We’re not there by any stretch. We’re not listening to newspaper vendors giving us stock tips, which is typically described as what happened back in the great crash of 1929. Nor are these newspaper vendors asking for stock reports on internet companies as they were in 2000. So, I would tend to say that there’s a lot more skepticism and disbelief in the marketplace today than you would expect to see at a bull market top.