​As Sam Sees It: Will Bulls Set to Buck History This Year?

Sam Stovall  |

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 now retaken the 2,800 level. Is this primarily due to the optimism surrounding this earnings period?

Stovall: Yes, I think that is the driving force. Earnings were expected to be about 19.5% for the second quarter but are now on pace to be above the 20% threshold, which would imply that this could be the 26th consecutive quarter in which actual earnings exceeded end-of-quarter estimates. In addition, earnings growth for full-year 2018 is now expected to be at 21%, as compared with the 11.5% that was expected just as recently as Dec. 31, 2017.

EQ: Do you think it is likely we’ll see new all-time highs before the reporting season is over?

Stovall: Yes, I do. We are within 2 percentage points of the Jan. 26 all-time high, so I think it is very likely that we end up eclipsing that number before the end of the month, if not the end of the week. That would put us well on the way for this bull market to become the longest bull market since World War II.

Also, we would find that the five-month period that it took to get back to break-even was similar to the five months required to get back from the 14% correction in 2015-16, and the near-bear market slump of 19.4% in 2011. Probably more encouraging, however, is history says, but obviously does not guarantee, that the S&P 500 could advance 10% beyond that prior all-time high before slipping into another decline of 5% or more.

EQ: If that happens, wouldn’t that buck the historical trend of what the market typically does in a midterm election year?

Stovall: Yes. The midterm election year is by far the most challenging of the four-year cycle presidential cycle, and the second and third quarters are the two most challenging of the 16 quarters. Yet, it is not out of the ordinary to have the market buck that trend. We saw that happen in 1950, 1954, 1958, 1978, and 2014 in which both the second and third quarters were in positive territory.

Now, what’s even more encouraging is that in the 12 months after midterm elections, the market has been up 100% of the time, gaining an average of 16.7%. But what happens if we have positive second and third quarters? Well, that doesn’t really change anything. The market has still advanced 16.7% without missing a beat.

EQ: In this week’s Sector Watch, you discussed the recent rise in inflation sparking concern for the market, but also explained why those concerns might be a bit premature. That also seems to be the sentiment Fed Chair Powell conveyed to Congress during his testimony this week. In fact, he actually stated that low inflation is still more of a concern. Does this indicate that this is a non-issue for the economy and market, at least in the near-to-intermediate term?

Stovall: Yes, but I’m glad you added that last part of “near-to-intermediate term” in the question. The headline PPI accelerated to a 3.4% pace on a 12-month basis and was followed by a 2.9% year-on-year advance for the headline CPI. The CPI number was the strongest since February 2012, and we all know that earnings and inflation are very important in trying to decide what is fair value for the overall market.

The differential between the CPI and the Fed funds rate is normally positive. Yet, close to the beginning of bear markets, it ends up inverting—similar to the yield curve. So, we are still about 12 months away from seeing an inversion of that CPI to Fed funds differential, which would therefore imply, but not guarantee, that we have some life left in this bull market.

EQ: That being said, the yield curve has continued to flatten over the summer months, currently with the spread at around 24 basis points. Powell said the yield curve won’t necessarily influence the Fed’s monetary policy, but it is watching it. What did you make of his comments?

Stovall: Yes, the yield curve has been narrowing over the past several months as defined by the difference between the 10-year yield and the 2-year yield, and that is a bit unnerving to investors. However, since 1960, the US has not slipped into recession without the yield curve averaging an inversion of 60 basis points. So, we tend to need an inversion of the yield curve before we slip into recession and a bear market, but also traditionally, it doesn’t happen simultaneously.

We can end up with an inverse yield curve for several months before we start a new bear market. So, it was encouraging at least to hear the Fed Chair say that they are monitoring the yield curve. Obviously, they’re aware of the kind of impact it can have on lending practices in particular, and therefore the economy in general, but their mandate is low inflation and low unemployment. So, that’s what they’re going to focus on while looking at the yield curve secondarily.

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