Each week, we tap the insight of Sam Stovall, Chief Investment Strategist, CFRA, for his perspective on the current market.
EQ: Earnings season is in full swing now, but things seem to be off to a slow start. What are your thoughts on results thus far?
Stovall: So far, we’ve got seven of the 11 sectors actually showing an improvement in earnings estimates as compared with their Sept. 29, end-of-quarter estimates. The only real big fly in the ointment has come from Financials. They were expected to post a 1.2% gain in operating results; now the estimate is for a decline of 6.2%. You might think that’s pretty horrible, but actually the estimate was for a decline in excess of 11% at one point, primarily because of the worry about insurance companies and the liabilities they will have surrounding the hurricanes in the third quarter.
As a result, on Sept. 29, the S&P 500 was expected to post a 5% gain in earnings. Now, that gain is expected to be 3.5%, which is certainly better than the trough of below-3% early in the reporting cycle. However, maybe this will be the quarter that will end up snapping the 22-quarter successive string of actual numbers that exceeded the end-of-quarter estimates.
EQ: Despite this softness, stocks have continued to notch all-time highs. What’s behind the strength of the market’s move?
Stovall: I think that the strength really is coming from investor optimism as it relates to the potential for tax cuts. We’ve been seeing this carrot dangle in front of investors for all of the months since President Trump was elected. It just seems to be a moving carrot that investors continue to be chasing after. Add to that, the organic growth in the US as well as global economies, combined with the double-digit earnings increases anticipated not only for this year, but for 2018 as well, and I think that’s led investors to feel that even if we don’t get a tax cut, the economy is improving, earnings are rising and so, the stock market continues to be the asset class of choice.
EQ: In this week’s Sector Watch report, you discussed the absence of volatility during the market’s continued ascension into new all-time highs. Is this a calm before the storm or can investors sit back and enjoy the smooth ride?
Stovall: Well, nobody has repealed corrections or bear markets, so after extended periods of calm, yes, there will eventually be a storm. But the real question is how long is it between the calm and the storm itself? For the past 40 years, the S&P 500 has seen an average of 67 days in which it rose or fell by 1% or more in the trailing 12-month period, and a minimum of 31 days before slipping into a decline of 10% or more. We have seen nowhere near that number this year. We’ve only seen 11 such days so far. The implication is we’re going to have to see an awful lot more volatility before it’s going to upend this boat.
Even if you look at a trailing six-month count of 1% moves, we’ve had five in the past six months as compared with a minimum of nine needed prior to declines of 10% or more. So, my feeling is that history would imply that we still have some upside potential. We’re in a very favorable period for the stock market—meaning the fourth quarter—in which the market has gained an average of 5% since 1990, all 11 sectors have posted price increases, and their batting average of quarterly price advances has been anywhere from essentially two out of every three years to more than 85% of the time. That’s obviously not a guarantee, but it’s something that I think could allow investors to sleep at night.
EQ: Outside of exogenous shocks, typically investors can see a correction coming in the form of increased volatility. While that may not happen this year even, when it does and there is that pickup in volatility, how should investors use this to their advantage?
Stovall: First, they can use it to their advantage by knowing that the market is going to go through challenging times. That would prepare them mentally to sit on their hands and not do anything about it. The reason is because, what if it does end up only being a 10-15% correction and not the beginning of the new bear market? On average, it’s taken the S&P 500 fewer than four months to get back to break-even from corrections. So, investors probably should be thinking about buying rather than bailing once we see a pickup in volatility, and therefore, go through a meaningful decline in excess of 5%.
EQ: That low volatility is a positive sign, but in addition, the breadth of the market advance does seem to offer another sign of stability. Are you noticing strength across the board?
Stovall: Yes, I am. Usually at bull market tops, you see a narrowing of leadership. Actually, the advance decline line prior to the popping of the tech bubble in 2000 started to turn downward in April 1998. Ditto for small and mid-cap stocks. It was really the large-cap tech stocks that ended up pushing their way higher.
In the week that just ended, 68% of the sub-industries in the S&P 1500 rose in price. There are 147 of these sub-industries, so essentially two out of every three of them were in positive performance in the past week. Also, about two-thirds are above their 200-day moving averages. So, I still believe that there is wide breadth of participation in this market advance.
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