Each week, we tap the insight of Sam Stovall, Chief Investment Strategist, CFRA, for his perspective on the current market.
EQ: In last week’s interview, we discussed the lack of 1% days for the market. On Wednesday, the market experienced one such day, sparked by turmoil coming out of the White House. What are your thoughts on this situation as it pertains to the market? Will it drive additional volatility going forward?
Stovall: Well, this now will represent only the fourth time year-to-date that the S&P 500 has risen or fallen by 1% or more in a single day. Since 1950, whenever we had five or fewer such days by the end of May, the market was actually higher 9.5% in the remaining seven months of the year and had posted a positive return 100% of the time. Of course, that is not a guarantee that it will happen this time. I think it certainly implies that a pickup in volatility can occur at any time, but in general, the underlying sentiment and fundamentals remain fairly positive.
EQ: You said recently that the market had given President Trump an “A for anticipation” up until now. However, as patience wanes on whether he’ll be able to deliver any meaningful policy changes in the face of these distractions, could that ultimately impact economic fundamentals?
Stovall: It won’t necessarily impact economic fundamentals, but it does impact investor expectations and, therefore, confidence and sentiment. I think the stock market was supported by the belief that President Trump will be able to put forward some sort of tax reform legislation. But now, because of questions surrounding a possibility of a special investigator and people are now even talking about impeachment, that could end up taking precedent over economic stimulative legislation that investors were relying upon. So, yes, the hype could morph into gripe, and we could end up slipping into that long-overdue 5% to 10% decline.
EQ: In this week’s Sector Watch, you looked at another potential key indicator of market turbulence in the Dow Theory. In particular, you pointed out the current divergence of the DJIA and Dow Jones Transport indices. What has this historically told us about the market?
Stovall: What it’s told me is that, looking at rolling 90-day trading correlations between the Industrials and the Transports, there is a connection. But it’s not a hard and fast trading rule. I’ve found that a majority of declines of 10% or more were accompanied or preceded by divergences between the Industrials and the Transports, but not all divergences resulted in declines. So, I would say that because we are more than two standard deviations below the mean in terms of correlation between the two indices, it has signaled a cautionary yellow light, but not necessarily a red alert.
EQ: When factoring in the Dow Theory and current market turbulence, as well as the sell in May period, would it support the thesis that investors should be getting defensive here if they haven’t already?
Stovall: I think it would at least imply that this May through October period could be as challenging as many have been in the past, which was why this old adage was created. We’ve gone 96 months in this economic expansion, which is more than twice as long as the average expansion since 1900. We have gone 15 months without a decline of 10% or more, which is longer than the median since World War II. Certainly, we’ve traditionally had pullbacks of 5% to 10% declines on average about every seven to nine months. So, we’re long overdue for one of those as well.
In general, if investors want to be buying on the dips, then maybe they should start at those more defensive issues that they have on their shopping lists, particularly those in the Consumer Staples and Health Care sectors. Should we end up with a more meaningful decline, then they should start picking up some of the more cyclical opportunities.
EQ: Despite the previously mentioned concerns for stocks, would investors still be ill-advised to sell out of the market?
Stovall: I have found that while the adage is sell in May, I think it’s better to rotate than retreat because the market has traditionally gone up about two out of every three summers, and the average price change has been 1.6%, which when annualized, is better than what you would get if you were in cash. So, if you wanted to take advantage of this tendency to get defensive, well then gravitate toward those sectors that do better in the May through October period, such as Consumer Staples and Health Care, rather than moving into cash and creating a taxable consequence.
