Each week, we tap the insight of Sam Stovall, Chief Investment Strategist, CFRA, for his perspective on the current market.
EQ: For all the talk of a Trump rally since the election, the market has actually been mostly flat over the past month. We saw this kind of muted price action heading into the election, which was subsequently followed by a major breakout. Is there a cloud of uncertainty that could be depressing stock prices in a similar way right now?
Stovall: Yes, I think that heading into the election, we had so many people say that if Donald were to be elected, then the market would sell off quite dramatically, but also the expectation was that the election would not go his way. The election did indeed go his way and the market took off.
Right now, I think we are seeing a similar level of skepticism where people are expecting the market to sell off once the inauguration has taken place, yet, I’m always reminded that the market tends to surprise the greatest number of people at any one point in time. Right now, should the market engage in any renewed rally, it probably would end up surprising a great number of investors.
EQ: President-elect Trump’s inauguration is Friday. The event itself is nothing new as it’s been expected for a while now. But is there anything in particular that investors should pay attention to for this momentous event?
Stovall: Maybe not the actual day itself. I’ve not done any analysis to see what happens in the market specifically on inauguration days. However, I have looked at the market’s performance in the 100 days after inauguration, or what’s called the Honeymoon Period. Historically, the S&P 500 has gained about 1.6% and has risen in price 70% of the time. The best performances by far have come under Democratic administrations, with the S&P 500 up 3.5%, rising in price 80% of the time. If history repeats itself, and obviously there’s no guarantee it will, then we might end up having returns that are a bit more challenging during this new Republican administration. To add another element of interest, this Honeymoon Period will end just as the sell in May period begins.
EQ: The first 100 days does start in the first quarter, and in this week’s Sector Watch, you looked at the prospects of a potential market pullback, and it appears we’re actually in what historically has been pullback season for the stock market. How often do pullbacks occur in the first quarter?
Stovall: Pullbacks traditionally occur about once every year, and looking at market declines of 5% or more, 70% of the years in which the S&P 500 was up actually saw a price decline of 5% or more take place in the first three months of the year. So more than eight out of every 10 years have seen a price decline at some point in time along the way. Obviously, the sooner you get these declines out of the way, the greater the likelihood that the year will be positive. So don’t be surprised if the market does go through a digestion of gains in the first quarter, because that actually is a fairly normal occurrence. Also, don’t be surprised if a pullback does happen in the first quarter that we’re back to break-even and then in positive territory before the year is out.
EQ: Is there any particular reason why the first quarter is ripe for this type of market behavior?
Stovall: Usually it’s because October, November, December and January have positive performances. As a result, I think there’s just the need for some sort of digestion of these seasonally optimistic gains. Traditionally, markets advance in a stair-step fashion. We take several steps forward, one step back. It’s when you see a continual advance is when you begin to get skeptical about how long the advance will last.
So, usually February is a down month. In fact, it’s the second-worst month of the year for the S&P 500, so we’ll just have to wait and see what happens in 2017.
EQ: If we do end up getting a sell-off here, there is a bright side you pointed to in this week’s report in that there may be enough evidence to suggest there’s enough bulls out there to support the market from falling too far. For investors looking to buy the dip, what are some things they should watch out for to determine it is a good buying opportunity versus the possible end of this bull market?
Stovall: I think the first thing you examine is the cause for the digestion of gains. If the cause is sufficient to warrant the possibility of our economy falling into recession, then it’s probably not a dip, and there could be an even greater and longer decline than a mere pullback. If, however, like a lot of stock market shocks that have occurred during bull markets, we find that they were unanticipated, however, were not likely to lead to recession and more times than not they do end up being good buying opportunities.
EQ: Watching the market try to eclipse Dow 20,000 has been like watching water boil. While most investment pros will say its relevance is driven more by financial media, it does beg the question of what investors should expect if and when stocks do surpass that threshold. Historically, what has the Dow done after crossing a key market like this?
Stovall: Well, traditionally what happens is after the Dow crosses a millennial level like going from 10,000 to 11,000, the market advances another 4% after breaking above that millennial level. It does that over a traditionally two to two-and-a-half-month period, then it goes through a decline of 5% or more in order to reset the dials. So traditionally, we break through that level, advance a little bit more, digest the gains, and then start to work our way higher, eclipsing the next 1,000-point level about two years down the road.
This time around, however, we not only eclipsed the 19,000 level but then got within less than one-half of one point from Dow 20,000 without experiencing a digestive decline of 5% or more. It’s only happened twice since Dow 10,000 and that was in 1999 and 2007, which were basically one year or less from a pretty substantial bear market. I think what it implies is markets do need to rest every so often, and if they don’t, then sometimes they collapse from exhaustion, and this time could be no different. If there is a positive element, it is that prior to both the tech bubble bursting in 2000 and the Financial Crisis in 2007 that once we did go through that post-millennial digestion of gains, we went on to hit new all-time highs before eventually slipping into those mega-meltdown bear markets.