Each week, we tap the insight of Sam Stovall, Chief Investment Strategist, CFRA, for his perspective on the current market.
EQ: July has been a very strong month for the S&P 500, up over 4% thus far, and is now within range to overtake the previous all-time high. While stellar earnings have been the main driver, investors have also been able to tune out all the macro and geopolitical concerns that were unnerving the market last month. Are investors just putting those issues on the backburner for now, or have the strong results led to a more bullish reassessment of the market going forward?
Stovall: I think investors have been focusing on second quarter earnings that have come in much better than expected. The initial estimate was for a 19.5% gain but it’s now looking closer to 21.5%. If history should repeat, the actual results should come in closer to 23%-plus. As a result, I think investors have put the geopolitical issues on the backburner for now, but they’re not ready to dismiss them altogether.
One reason is that the administration is now thinking about imposing a hefty tariff on hundreds of billions of dollars of foreign made cars. In our opinion, that could cause the global economic growth to sputter, if not stall out. Add to this the implication that consumer optimism is on less-than-solid footing due to the weakness in recent new and existing home sales data, and uncertainty could become synonymous with volatility.
EQ: Speaking of volatility, in this week’s Sector Watch, you also noted that volatility has been both elevated and subdued. What do you mean by that?
Stovall: There are two ways you can look at volatility, and in some ways, they’re in disagreement with one another. The first way is by counting up the number of days in which the S&P 500 rose or fell by 1% or more in a single day. So far this year, we have seen 38 such days, which actually equates to 65 days on an annualized basis. That is actually higher than the traditional amount of 50 days normally seen in any particular year, but also higher than the more normal 58 days found in the uncertain and volatile midterm election years.
However, if you look at all of the days and their volatility—in other words, the daily price volatility—we are actually coming in 6% below the average since 1945. In this quarter alone—granted we’re only a third of the way through it—average daily volatility is tracking 45% below the typical volatility seen in the third quarter of midterm election years. So, I guess it’s like a glass being either half full or half empty. If you’re an optimist, then look to the lower volatility because on average, lower volatility tends to imply higher prices since daily volatility is typically more than 20% higher during down days than during up days.
EQ: Recently, we discussed the flattening of the yield curve. It seems President Trump has been keeping an eye on that as well, calling for Fed Chair Powell to take action—or rather, less action. What kind of impact does this new dynamic pose to the market?
Stovall: Well, it has shown investors that the market has eyebrows, because it caused the market to raise those eyebrows. The Fed is meant to be independent from government pressure. Yet, we are seeing the President try to jawbone interest rates lower and cause Fed Chair Jerome Powell to move a bit more cautiously. I don’t think that will be the ultimate outcome because the Fed’s mandate is low unemployment, along with manageable inflation.
I think the Fed realizes that it now has a window of opportunity to increase interest rates and add arrows to its quiver before the next recession hits, and it will take advantage of that opportunity. So, while the President would like economic growth not to slow as a result of higher interest rates, he might not get his wish, and he could end up fighting a double-front war in the form of higher interest rates and inflation, along with increased trade tariffs.
EQ: Last year, CFRA introduced the CFRA-Stovall Seasonal Rotation Indices, which tracks your seasonal rotation strategy of buying and holding cyclical sector plays during the November through April months, and then rotating into defense sectors during the sell in May period. Can you tell us about the approach that these indices are based off of and how they’ve done since the launch?
Stovall: I wrote a book back in 2009 called The Seven Rules of Wall Street, which looked at seven old Wall Street axioms to see whether an investor who wanted to embrace a rules-based investment approach could actually profit from such a set of investment rules. Not surprisingly, the answer was yes.
In particular, this alternative to the sell in May strategy says that you really should rotate, not retreat, and that you should gravitate toward the more defensive Consumer Staples and Health Care sectors in the traditionally challenging May through October period, but then focus on the more cyclical Consumer Discretionary, Industrials, Materials and Tech sectors in what I would call the cyclical six months of the year in which the market tends to do very, very well.
I also found that this kind of strategy worked very well not only with the large-cap S&P 500, but also the Equal Weight S&P 500, the SmallCap 600 and the Global 1,200. This index goes back to 1990 for the cap-weighted S&P 500 and Equal Weight S&P 500, and back to 1995 for the SmallCap 600 and Global 1,200. In each case, we had the strategy outperform the benchmark by anywhere from 350 to 650 basis points per year, with equal to or lower overall volatility.
EQ: For investors interested in this approach, there’s now an easier way for to implement the strategy. Can you tell us about the Pacer CFRA-Stovall Equal Weight Seasonal Rotation ETF
Stovall: The CFRA-Stovall Seasonal Rotation custom index tracks selected sectors of the S&P 500 Equal Weight Index. On October 31 of each year, the index will initiate a 25% exposure to each of the consumer discretionary, industrials, information technology and material sectors. On April 30, the index rotates into an equal weighting of the defensive consumer staples and health care sectors. We are proud to announce that just this Tuesday (July 24), Pacer introduced an ETF that tracks this index. Please visit www.PacerETFs.com to learn more.
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