Each week, we tap the insight of Sam Stovall, Chief Investment Strategist, CFRA, for his perspective on the current market.
EQ: This week in a CNBC interview, you warned investors that this bull market could end with a 40% decline or more. What are some of the reasons behind this call?
Stovall: Well, because we’ve set a new duration record with the length of this bull market, combined with the fact that we’re up more than 300% since the March 9, 2009 low—the average price gain for bull markets since World War II is about one third of that—and with the P/E ratio being the second highest since WWII, investors have asked me what does all this imply for the next bear market?
History says that if you are above the median of all bull markets since WWII, then the bear market that you fall into tends to be among the deeper ones. Based on the duration and the total percent change, if you’re on the high side of things, the average decline has been 38%. But based on the valuation of the market at the top, by us being at the second-highest, that implies that we could be seeing about a 41% decline based on the averages since WWII.
EQ: We’ve discussed before that you’re still modestly bullish for 2019, and it’s unclear when the next market meltdown will happen. With that said, what could potentially trigger it?
Stovall: I think domestically, if we see things just get too out of hand. If we see this economy, which seems as if it’s catching fire, becomes uncontrollable and the Fed has to get more aggressive, not only in the timing of their rate increases but also the magnitude, then I think that could throw the market for a loop.
If we also find that we have problems overseas, such as with the Italian banks, issues with emerging markets, and so forth, because with the strengthening of the US economy, that will likely boost up the value of the US dollar. Since a lot of the debt for emerging markets is priced in US dollars, that puts them increasingly in a bind and that could trigger some sort of emerging markets problem. Those could end up reverberating back here in the States.
So, who knows exactly what will happen? Usually, bear markets are triggered by expectation of recession here in the US, and I think the yield curve is what most people are looking at.
EQ: You’ve said before that bull markets typically go out with a bang; not a whimper. Considering that we’ve had an uncharacteristically strong midterm election year third quarter and are expecting a strong fourth quarter, could this be that bang?
Stovall: It could certainly be because usually the second and third quarters of midterm election years are negative, but in the past six months, we’ve had very strong performances. The third quarter was up 7.2% versus normally being down by about 1%. As a result, you could say that maybe things are getting a little out of hand and that the bull market, much like incandescent lightbulbs that tend to glow brightest just before they go out, may be starting to brighten up, which could end up presenting a problem down the road.
EQ: The fourth quarter is usually very kind to investors, particularly in midterm election years. It’s seems this is when a majority of sectors have their best performances by far. How good has the market been during this time of year?
Stovall: The market has been very good. Going back to 1990, which is as far back as S&P has sector level data, we’ve found that while the S&P 500 traditionally has gained 5% on average and risen in price 82% of the time, we have such sectors as Technology being up 6.5%, Consumer Discretionary up 6.2%, and Industrials and Consumer Staples tied at 5.9%. So, there are quite a number of sectors that have outperformed. Financials, Materials and Health Care are other groups that have done well too.
In fact, every sector was up in price, though not surprisingly, many of the defensive areas did not do as well. Real Estate was up 1.5%, Telecom was up 4.4%, and Utilities was up 2.6%.
The batting averages have also been very pleasing to investors. Consumer Discretionary and Consumer Staples were up 86% of the time, as was Health Care. Tying the market, we had Financials and Industrials up 82% of the time, and then lastly, Tech and Materials up nearly 80% of the time. So, the frequency with which these sectors have had positive moves in addition to the average magnitude has been encouraging. It would seem that, certainly based on how we’re doing thus far in October, investors could be pleasantly surprised once again.
EQ: We talked about the new Communication Services sector in last week’s interview, and when you look at how this new group stacks up with the other sectors, it’s at around the middle of the pack. Is that because it’s kind of a mixed bag of defensive Telecom and cyclical Tech and Consumer stocks that were recategorized?
Stovall: Well, I think it’s actually leaning a little more toward the cyclical side than it is the defensive side. It’s now more of a cyclical group than being 50-50. Communication Services, which officially was introduced at the end of September, is showing a dividend yield of 1.4% versus the 5.4% for the Telecom Services group.
We’re also looking at a beta that is twice that of Telecom’s 0.6. That’s because you have companies in there like Facebook (FB), Netflix
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