Each week, we tap the insight of Sam Stovall, Chief Investment Strategist, CFRA, for his perspective on the current market.
EQ: While stocks enjoyed a nice move higher initially following the midterm elections, they’ve given back those gains and then some. What’s got the market jittery right now?
Stovall: I think it’s because of two things, as I had mentioned earlier, it is PEs—politics and earnings. Politics because we are now in a split Congress environment, which historically has not been very good for stocks. I think investors are worried about the lack of stimulus, which could aid economic growth as well as corporate profits, which then leads to earnings.
While earnings are coming in better than expected this quarter, every sector as well as every asset size—large cap, mid cap, and small cap—have seen their earnings estimates reduced for 2019. Then, when you deal company by company, especially with such high-fliers as Apple (
I think right now it really is uncertainty that is driving the market as well as a retest of the Oct. 29 low, and whether that low will hold.
EQ; In this week’s Sector Watch, you looked at the market’s performance following midterm elections with a longer view. In terms of the three, six and 12 months after midterms, how has the market tended to perform?
Stovall: It’s actually tended to perform pretty well. The remainder of the year (November and December), we have seen the market rise about 67% of the time and post positive performances that rival other periods of the year. In fact, the fourth quarter of midterm election years are the best on average of the entire 16-quarter presidential cycle.
The second and third best quarters are the ones following this one—meaning the first quarter and second quarter of next year are the second and third best performing quarters on average. The November through April period, which are the best six months of the year according to The Stock Trader’s Almanac, also have proven very resilient following midterm elections.
Finally, for the 12-month period—Oct. 31 of midterm years until Oct. 31 of the year after—the market has risen 18 of 18 times and gained nearly 17% in price. So historically, markets say you’re better off buying than you are bailing right now.
EQ: You also looked at the market’s performance on a sector level, and while historically strong gains were seen just about across the board, some groups could be better positioned than others as we enter 2019. Which sectors are showing the most promise in this political environment?
Stovall: Well, going back to 1990, those sectors that have posted 100% positive performances following midterm elections have been Health Care, Industrials, and Information Technology. A close second with a gain of 86% were Consumer Discretionary and Consumer Staples. Obviously, none of those performances should serve as a guarantee, but it just tends to reflect the positive nature of stocks in general after midterm elections.
I think that investors have been focusing favorably on the Health Care group because of the likelihood that the Democrats will not be putting pressure on pharmaceutical prices, mainly because they’re looking to undermine the Republicans and are going to focus on that. In terms of Industrials, should we end up with some sort of trade agreement from the G-20 meeting at the end of November, I think that would take pressure off some of these multi-national firms that have been hit hard by these trade tensions.
Lastly, yes, we have been seeing a resetting of the dials for Technology in terms of earnings growth and prices, but we’re not dealing with 2000-like multiples here. The S&P Technology sector was 2 percentage points above the S&P 500 in terms of P/E ratios, not 2 times as it was back in 2000. So, I still think Technology has growth potential ahead of it, but we’re just simply readjusting the optimism toward that group.
EQ: For quite some time now, investors did very well by relying on a momentum-based approach. As the market works its way through this correction, however, investors may be tempted to buy some dips. Where do you stand on buying winners or losers in the near and intermediate term?
Stovall: Well, as you know, I do have an Industry Momentum Portfolio, which buys those S&P 500 sub-industries that are in the top 10% based on the trailing 12-month price performance and then sells them when they fall out of the top 30%. It is a rules-based approach that forces investors to buy the dips, if you will, or to stick with the winners until they are no longer winners.
Obviously, this technique does not work 100% of the time, but it still is leaning toward the Consumer Discretionary, Industrials and Technology sectors. However, it has seen an increase in the Consumer Staples and Health Care groups, possibly as investors look to balance their portfolios and remove a bit of the risk associated with the really high-flying areas.
So, because we don’t think that a bear market is around the corner, we do believe that investors are better buying than they are bailing. With that said, I would not be surprised if we do end up undercutting the Oct. 29 low for the S&P 500, which was off 9.9%. I think we could end up with a decline that is closer to the low-teens, like 13-14%, when all is said and done. Then I would look upon that as a good buying opportunity for the next six to 12 months.