Each week, we tap the insight of Sam Stovall, Chief Investment Strategist, CFRA, for his perspective on the current market.
EQ: Generally speaking, the midterm election results came in just about as expected with Republicans keeping the Senate and the Democrats taking the House of Representatives. The market reacted favorably to this. Is this because there were no real big surprises?
Stovall: I think one could assume that. Maybe the market thought there was the potential that there could be a blue wave or a red wave, but basically Wall Street is saying it prefers some sort of check and balance without much of a surprise. That way, they can focus more on corporate profits and fundamentals in general.
EQ: Now that the midterms are behind us, what does that mean for stocks in terms of the scope of uncertainty that has now been removed from the market? What is the focal point going to be moving forward?
Stovall: Well, now you start focusing on those items that are still ahead of you. One of the concerns that was facing investors was the trade disagreement between the US and China. Well, that’s still out there. However, there’s a G-20 meeting at the end of November and maybe negotiations can be restarted.
Also, the Fed will likely be raising rates in December and then raising rates additionally in 2019. Maybe their press conference will imply that they are less likely to be as aggressive in 2019 as Wall Street happens to believe. So, there is still some potential going forward that could turn the mindset of investors around.
In general, technicians and chartists are still cautious, saying the market still remains below levels of resistance, so I think there has to be some more proof that there is resiliency behind the latest advances.
EQ: So, just because the midterm uncertainty is out of the way, it doesn’t necessarily mean the volatility that we saw in October is over?
Stovall: Correct. The volatility is certainly not over, but if you do have a long enough horizon, history would say that you really don’t want to bet against the market in the coming 12-month period. Just going back to 1990, based on sector performance as well as the market’s performance, the S&P 500 was up 100% of the time 365 days after midterm election day. You had similar kinds of performances for Health Care, Industrials, Technology and also very high-performance track records for Consumer Discretionary, Consumer Staples and Energy.
In fact, the worst batting average was Real Estate, being up two out of every three years, but that’s only because they only go back a few years, not beyond 2006. So, history says you don’t want to be too cautious in the 12 months after a midterm election.
EQ: In this week’s Sector Watch, you took a deeper dive into market seasonality and sector rotation. November does mark the beginning of the strongest six months for the market, and you discussed a few potential contributing factors for this. What are some possible reasons for why November through April tend to outperform the sell in May through October period?
Stovall: Well, I found predominantly that it’s a matter of capital inflows. The reason the market is strong traditionally in the early part of the year is because pension funds tend to put money to work early in the year. Also, employees get paid bonuses early in the year, which tends to help max out their 401Ks. Even if you’re not getting a bonus, you tend to max out early in the year. If you’re getting a tax refund, you typically apply it before April 15, and if you have an IRA, you need to fund it before April 15. So, really, the thought is that a lot of capital inflows occur early in the year.
For the summertime months, a lot of that is vacation-influenced. Also, by the third quarter, you tend to adjust end-of-year earnings estimates, usually also getting rid of the dogs in your portfolios, especially for mutual funds, which have fiscal years that end in October, which sets us up quite nicely for a beginning period for November through April. So, a lot of volatility in October tends to then represent a good buying opportunity that carries over into April of the next year.
EQ: Looking at how the market’s performed this year—softness for most of the year and entering a correction in October—do you think it is positioned well, particularly the cyclical sectors, to shine in the coming months?
Stovall: Yes, I do. I think historically because we have entered what I call the “Cyclical Six” and what The Stock Trader’s Almanac refers to as the best six months of the year, it goes naturally that the higher-beta, more-growth areas will tend to outperform in a rising stock market environment. It’s usually in the May through October period where the market activity is uncertain that investors will then gravitate toward the more defensive areas of the stock market.
So, right now it’s sort of a matter of correlation. When stocks go up, the cyclicals tend to do better. When stocks are flat or lower, the defensive sectors tend to shine, and that’s what we’re seeing this year as well.
The Seasonal Rotation strategy is tracked and monitored via the CFRA-Stovall Seasonal Rotation indices, calculated by S&P Dow Jones Indices. For information on the indices, visit: https://customindices.spindices.com/?custom_client_name=cfra
For information on the Pacer CFRA-Stovall Equal Weight Seasonal Rotation ETF, which tracks the Pacer CFRA-Stovall Equal Weight Seasonal Rotation Index, visit: https://www.paceretfs.com/products/szne
