Each week, we tap the insight of Sam Stovall, Chief Investment Strategist, CFRA, for his perspective on the current market.
EQ: June proved to be a good month for the S&P 500 with the index looking like its bumping up against the all-time high heading into the second the half. As you noted in this week’s Sector Watch report, the market is up 9% in the first half of this year without much of a digestion along the way. The obvious question is, is this too much too fast?
Stovall: It’s not too much too fast according to history. Going back to World War II, whenever the S&P 500 rose between 7% to 12% in the first half of the year, it went on to advance an average of 5% in the second half, and rose in price 87% of the time, which was the best of any quintile of first-half performances pointing to second-half results. History is a guide and never gospel, but it implies that because we have not seen a skyrocketing of share prices in the first half, investors believe good things are still to come. As a result, there’s a very good likelihood that we could end up seeing even higher prices before the year is out.
EQ: The Trump administration and Republican-controlled Congress haven’t had as much of an impact on the markets, at least on the surface, as investors may have expected heading 2017. Could that potentially change in the second half, or are investors beginning to look beyond politics?
Stovall: As I’ve said before, politics make for good headlines, but it’s the economy that affects the bottom line. I think that’s what investors are focusing toward. What kind of growth are we expecting for this economy in the second quarter of this year, as well as the second half? Expectations are that we’ll probably see a 2.8% growth in real GDP in the second quarter, and approximately that amount for the entire year, with the second half growth being a shade above 3%.
Corporate earnings are expected to be up about 10.5% for all of 2017, and are expected to be higher by 6% in the second quarter, which will be reported just a couple of weeks from now. But that 6%, as we have seen in each of the last 21 quarters, will likely be exceeded by actual results. Again, if history is a guide, we could end up seeing second quarter earnings up closer to 10%.
EQ: From a sector standpoint, there was some rotation that occurred in June, most notably Technology showing weakness and Financials showing some life. Is this just investors positioning for the second half?
Stovall: Well, I think investors are gravitating toward the Financials because interest rates seem to be creeping higher. The Fed seems determined to raise rates at least one more time this year, and Financials seem to do well when the long end of the yield curve steepens as the shorter end continues to plod higher with every Fed action. Since banks need that spread between the short and long rates to make money, investors have just been buying into Financials toward the end of June because that yield curve has been steepening.
We do think the yield curve will remain where it is or steepen a little bit further between now and the end of the year, so many of the Financials stocks could do relatively well. Meanwhile, earnings for Tech is expected to be strong in the second half of this year, but a lot of that has already been discounted, in our opinion. So, Tech will probably end up being more volatile, and there are probably more opportunities left on the Financials side.
EQ: Speaking of interest rates, ECB President Mario Draghi’s comments earlier this week, which he has since walked back, but could we potentially be looking at a less stimulative environment on a global scale in the second half of this year?
Stovall: If it’s not an actual reduction in stimulus, I think it does reduce expectations of stimulus as we head into 2018. Over the last several years since the Financial Crisis, both domestic and international central bankers have been attempting to stimulate economic growth, and in many ways, serve as the consumer of last resort. But now that the economies are improving, the central banks feel that they have to unwind a lot of this stimulus in order to add arrows back into their own quivers with which to fight the next recession, whenever that should come. If we don’t see an actual reduction in stimulus, I certainly believe that expectations will be rising that it will happen in the coming year.
EQ: As we discussed in a previous interview, you advised that in this market environment, investors would likely do better by riding the market momentum and letting their winners ride. Heading into the second half, who are the winners that investors should lean toward?
Stovall: As I wrote in the most recent Sector Watch report, we have been seeing an improvement in many different sub-industries within the S&P 1500, which consists of the LargeCap 500, MidCap 400 and SmallCap 600. Some ideas we’re looking at, in particular, include Asset Management and Custody Banks that have seen improvement in their momentum. We’ve also seen improvement in Consumer Finance, Electronic Manufacturing Services, Real Estate Development, as well as Tires & Rubbers. As I wrote in this week’s Sector Watch report:
Since the S&P 500 remains close to its all-time high, it may be prudent to monitor those groups with improving relative performance. There are 147 sub-industries in the S&P 1500 Index, and 15 of them saw increases in their current relative-strength ranking (RSR) over their RSR from four weeks ago. RSRs represent trailing 52-week price performances where an RSR of 5=Top 10%,4=Next 20%, 3=Middle 40%, 2=Next 20%, and 1=Bottom 10%. These rankings historically have served as a fairly reliable indicator off forward price performance. Of course, there is no guarantee that what worked in the past will work again in the future. The S&P 1500 sub-industries with rising RSRs are listed in the accompanying table, along with this week’s RSR and that of four weeks ago, the group’s cap-weighted CFRA STARS ranking, and a stock within each sub-industry with the highest STARS ranking to serve as a sub-industry proxy.
We have been seeing this improvement in momentum across the board, which is encouraging because we have seen it in Financials, Information Technology, as well as Real Estate and Consumer Discretionary. So, because this improvement isn’t just occurring in one or just a few groups, it would provide support that this market still has some upside potential
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