Each week, we tap the insight of Sam Stovall, Chief Investment Strategist, CFRA, for his perspective on the current market.
EQ: While stocks have regained bullish momentum after finally closing the most recent correction, the market’s high-flying tech sector seems to be caught in the middle of a number of political firestorms. Executives from social media giants like Facebook and Twitter are testifying in front of Congress this week, Google’s search has been called out by President Trump, and Amazon finds itself in the crosshairs of Sen. Bernie Sanders for its employment practices. Is this particular group too hot to touch at the moment?
Stovall: No, I don’t think so. We still have overweight recommendations not only on the sector but also on several of the 14 sub-industries within the sector, such as IT Consulting, Communication Equipment, Hardware as well as Electronic Manufacturing. Those are all areas where our analysts think there is still some good upside potential. Areas where they’re less enthusiastic include Data Processing, Electronic Components and Electronic Equipment & Instruments, which are probably some of the duller sides of the Technology coin.
EQ: As you pointed out in this week’s Sector Watch, the S&P 500 has enjoyed a sensational summer thus far. However, considering that September has historically been by far the worst month for the market, could we anticipate a bit of a give-back in the coming weeks, or is it likelier that momentum carry stocks higher?
Stovall: Well, the probabilities point to a digestion of gains in September. If you look at all Septembers since World War II, the market has posted a decline of nearly 1% and fell more often than it rose on the month. Even when you look at Septembers in midterm election years, the results are fairly similar—a decline in average price change as well as a frequency of decline that’s greater than the average for all other months. So, I would tend to say to at least be prepared for some digestion of gains. That way you won’t be overly disappointed.
At the same time, as we’ve discussed before, the market does tend to perform quite well in the final quarter of a midterm election year, as well as in the October-to-October 12-month period that follows. I’d also like to add another encouraging historical data point in that only once did we have a midterm election year that saw five successive months of price gains as we did this year—meaning April, May, June, July and now August in positive territory. That happened in 1958, and surprisingly, the market continued to rise for the remaining four months of the year and posted a near-4% advance on average for each one of those months.
EQ: With that in mind, investors will want to position themselves to play that trend. In this week’s report you reiterated the promising prospects of the cyclical groups going forward. Is there any common theme to the type of industry groups that you’re seeing?
Stovall: Yes, from a very broad perspective, they are cyclical, but then more specifically, the cyclical sectors that are doing quite well are the Consumer Discretionary, Industrials, and Technology, with a smattering of Energy, and to a lesser extent Health Care. So, your more traditionally cyclical areas that relate to the consumer, businesses as well as to technology are showing the best performance.
Automotive Retail was recently added to the list. Also, Oil & Gas Drilling recently entered the top 10% on a trailing 12-month price performance basis, which is the criteria for entering the Industry Momentum Portfolio. In Health Care, Life Sciences, Tools & Services was added to the overall list. So, in general, we do have some names that are holding up quite well, and as a result, are likely to continue to do relatively well.
EQ: Recently, the CFRA Investment Policy Committee raised its 12-month target for the S&P 500 to 3,100. Can you provide some more insight to that decision and what that says about the market and economic environment over the coming year?
Stovall: At first glance, you might think that we’re raging bulls when in fact this new target of 3,100 represented only about a 7% price appreciation in a 12-month period. So, that would underscore our description of ourselves as being bulls but with a lower case “b”. Our belief is that, yes, things look marvelous right now. Economic growth is on the upswing, corporate profits are above 20%, inflation remains low, interest rates remain stimulative, and so forth. But we question how much longer this can last, and based on our own assumptions of GDP growth, earnings estimates, and so on, the headwinds will come from tougher comparisons in 2019 versus 2018.
Heading into 2018, for example, Wall Street analysts believed the S&P 500 was only going to show about an 11.5% increase in corporate profits. But because of windfall from the late-2017 tax reform, corporate earnings are now expected to be up more than 22%. So, it was almost a doubling of the estimate as a result of the tax cuts. So, as a result, we really don’t think 2019 is going to see as strong of an advance as we saw in 2018. In fact, we think it will be about half—with a 10% gain in EPS versus the 22% for this year.
EQ: We’ve discussed that historically the market sees an average 9.5% gain after recovering from a correction. Factor that in with the anticipation for a strong fourth quarter once the midterm elections are over and with CFRA’s 12-month target of 3,100, would that suggest that you anticipate most of that modest 6.5% move to be frontloaded in the coming months? Would that also suggest that 2019 could potentially be that much more challenging?
Stovall: Yes, I think that’s a logical assumption in that we end up having most of the euphoria occur in the traditionally seasonally favorable fourth quarter of any particular year. But as we head into 2019, usually the first and second quarters tend to do relatively well, but then things peter out as we move into the second half of the third year of the presidential cycle.
In general, the fourth quarter of the midterm election year, combined with the next two quarters tends to be the three strongest quarters of the 16-quarter presidential cycle, but then investors tend to run out of gas and we end up with average to below-average returns in the second half of the year following midterm elections.