Each week, we tap the insight of Sam Stovall, Chief Investment Strategist, CFRA, for his perspective on the current market.
EQ: The S&P 500 has gotten back to making new all-time highs now. Does this send a signal to the market that a risk-on environment could be returning?
Stovall: Yes, it does. I’ve gone back in time to look at what traditionally happens whenever the market has gotten back to its all-time high after falling anywhere from 10-20%, which is the definition of a correction. What I have found is that the market tends to rise about 9.5% before falling into another decline of 5% or more.
Obviously, that’s just the average—some are less, some are greater—but it does imply that now that we have recouped what we lost and because there was a bit of dial-resetting, it allows the market to work its way higher.
EQ; The market has bucked the trend of the sell in May period thus far this year, and that’s particularly noteworthy since it is also a midterm election year. What do you make of this historical anomaly?
Stovall: Well, basically whenever you have a midterm election year, uncertainty reigns. Usually, the second and third quarters have been negative, and are actually the two worst quarters of the 16-quarter presidential cycle. But this time around, the market has actually done relatively well. It’s not necessarily a total change with history though, because about 40% of the time the market has gone up.
When it has bucked the trend, it actually has been very favorable for the month of September. Instead of being down an average of 1% and falling 10 of 18 times, the market ends up being in positive territory. What’s more, it did not take away from the gains normally then seen in the fourth quarter following the midterm elections, as well as the subsequent 12-month period (October of the midterm election year through the next October). Usually, that performance is also very strong.
What it implies is that the market had nowhere else to go that was more attractive than stocks, and it was encouraged by the earnings growth that was reported for the second quarter, and it still has high hopes for the rest of the year.
Stovall: Well, they were in some ways unbelievably good. The fourth quarter of midterm election years posted an average increase of 7.5%, and only in two observations did the market slip. One time was in 1994 when it was down only 0.7%. So, you can almost say it was flat. Also, in 1978 it was down a shade more than 6%. But in most other cases, you had gains that went as high as 21%, like in 1998. This time around, a lot of pundits believe the Democrats will regain the House. Well, the market still does pretty well when there is a change to either the House or Senate majority, up almost 6% in that final quarter.
Taking that one step further, from Oct. 31 through Oct. 31 of the subsequent year, the market has gained nearly 17%, was up 100% of the time, and posted a double-digit advance regardless of whether there was a change or no changes to the majority. One of those observations included the meltdown of 1987. So, obviously it’s not a guarantee, but it does imply that once the uncertainty of the midterm election has run its course, the market does have some staying power in the year ahead.
EQ: So, the market tends to prefer the status quo?
Stovall: Well, if there is no change to the majority, then the fourth quarter has risen an average of 9%. If there is a change in either the House or the Senate, or both, then the market has risen about 6% on average. So, it’s still positive, just less optimistic.
The same can be said for the 12-month period from Oct. 31 through Oct. 31. If there was no change in the congressional makeup, then the market was up nearly 20% in that 12-month period. If there was a change in one or both houses of Congress, then the gain was 13%. So, again, 100% frequency of advance. It’s just the magnitude of that advance was more muted when there were changes because obviously, there’s probably going to be more pushback from one or both houses of Congress.
EQ: In terms of sectors or areas of the market, where should investors look toward to prepare for this potential “PEP”?
Stovall: I think you want to adhere to the old adage of “let your winners ride.” We’ve been seeing a shift toward the higher-momentum, higher-growth categories. I think that’s mainly because investors have wondered just how long this bull market will last. Let’s face it, we did just set a new duration record and at the same time, hit a new all-time high, so that has been favorable.
Now the question is where do investors go? We’re still leaning cyclically, looking at the Consumer Discretionary, Industrials and Technology sectors as found in my Industry Momentum Portfolio. If you were looking for a little bit of defensiveness, you might want to gravitate toward Health Care stocks, but in general, I think you want to let the trend be your friend, and right now, it says remain growth- or cyclically-biased.
