​As Sam Sees It: With Markets Heading for Turbulence, Investors May Want to Sit Tight

Sam Stovall  |


Each week, we tap the insight of Sam Stovall, Chief Investment Strategist, CFRA, for his perspective on the current market.

EQ: Last week, Facebook  (FB) shocked the market with a major guide down of its growth rate, sending shares plummeting over 20% as a result. The amount lost in the drop exceeded the entire value of some of the largest blue chips in the market. What kind of impact does that have on the broader market, when such a behemoth stumbles like Facebook did?

Stovall: Well, of course it has an impact not only on the share price of the S&P 500, but also on the outlook of the average investor. The first question that they ask is if this is simply the beginning of a series of disappointments moving forward, and you have to then watch the underlying performance of the market to see whether investors indeed think it is time to retreat, or simply to rotate.

I would say that I was encouraged by the sub-surface action since the Tech sector’s top on July 25 because, through the end of the month, while the S&P 500 fell 1% and Technology fell 5%, seven of the 11 sectors were higher by nearly 1% or more in this same timeframe. That indicates to me that investors were still willing to stick with stocks, just moving to those areas that did not deserve to be beaten up.

EQ: In our recent interview, we discussed the likelihood of the S&P 500 finally completing the correction that started in early 2018. Perhaps because of Facebook and weakness in other Tech stocks, it has yet to do so, and it seems that upward momentum has dissipated a bit over the past week. What key levels should we watch to determine the market’s direction, one way or another, in the near term?

Stovall: You’re right in that the upward advance for the market seems to have been short circuited by the sell-off in many of these social media companies. Also, we saw the small-cap stocks and the Nasdaq 100 move into sort of a rotational bias because of the recent sell-off. The S&P 500 is still the only major index to be maintaining its bullish bias. What I think is happening is we are getting a retest of the recent breakout from the trading range.

Should the S&P 500 remain above the 2,789 level, then it would imply that it was a successful retest and that the S&P 500 could continue its upward trajectory, and possibly establish a new all-time high before August 22, which would signal from a time perspective that this bull market has become the longest since World War II.

EQ: In this week’s Sector Watch, you detailed the historical softness of the August and September months during midterm election years. As we enter the thick of it now, do you anticipate more herky-jerky market swings as the earnings catalyst runs its course? Or could the strength of the earnings carry the market through this period?

Stovall: I think actually the answer could be yes to both questions. One is that, yes, we probably will end up seeing more herky-jerky movement simply because it is the third quarter of a midterm election year, which is characterized by uncertainty. As a result, we could end up seeing a greater amount of volatility. At the risk of repeating myself, what I have found is that in the third quarter of midterm election years, average daily volatility has risen by about 34%, as compared with the average volatility in the non-midterm election third quarters.

That said, we could still be up for the entire quarter on a price basis, because even though the second and third quarters of midterm election years are traditionally the most challenging within the 16-quarter presidential cycle, because we actually did end up seeing a positive second quarter, that actually encourages the possibility of a positive third quarter in this midterm election year. So, yes, I think volatility will probably pick up, but I think there’s a good possibility from a price-change perspective we could still be looking at a positive quarter.

EQ: Historically, the October through December period of midterm election years have been very good for bulls. Would it be advisable to use these two months to prepare for that potential upward move, or does the anticipated volatility make it too risky for any significant portfolio adjustments during this period?

Stovall: Well, I’m not a successful short-term trader, so I would not be encouraging someone to try to catch bottoms and sell at tops, but I would use history to help calm a nervous investor’s perspective by saying that while volatility will likely increase in the third quarter, the market has traditionally done quite well in the final two months of the midterm election year.

Indeed, it has a perfect track record when you look at the 12-month performance from Oct. 31 of midterm election years through Oct. 31 of post-midterm election years. The market has risen 18 of 18 times with an average increase being 16.7%. So, I would tend to say that if you are nervous and likely to want to sell out due to the expected increase in volatility, I would recommend sitting on your hands, because traditionally, the final two months of the year as well as the 12 months beyond the midterm elections tend to be quite favorable for investors.

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to: http://www.equities.com/disclaimer

Companies

Symbol Name Price Change % Volume
FB Facebook Inc. 181.11 1.06 0.59 19,101,995 Trade

Comments

Emerging Growth

MGX Minerals Inc.

MGX Minerals is a diversified Canadian mining company listed on the Canadian Securities Exchange. MGX is engaged in the acquisition and development of industrial mineral deposits in western Canada that…