Interview With Sam Stovall: Although Congress Impedes, Not Leads, 2.7% Economic Growth In 2013, 3% In 2014

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Includes: DIA, QQQ, SPY
by: Harlan Levy

Sam Stovall is chief equity strategist at S & P Capital IQ as well as the author of The Seven Rules of Wall Street and the column Stovall's Sector Watch, a page on marketscope.

Harlan Levy: What do you think will be the effect of the sequester on the economy?

Sam Stovall: While our chief economist believes that it could trim economic growth by maybe one half of 1 percent in 2013, I look more at the stock market's response to the sequester and am encouraged by a continued upward climb in equity prices, despite the sequestration kicking in. I look to the S&P 500 Aerospace & Defense Index rising 2.7 percent in February versus 1.1 percent for the S&P 500. That tells me that the market is not worried about the impact of sequestration on the economy or corporate earnings.

H.L.: So where do you see stocks going this year and next year?

S.S.: Our belief is that stocks are getting fairly close to our year-end target of 1,550 on the S&P 500. We believe that equity prices will challenge the all-time high and possibly even surpass it, yet will run into formidable resistance from a technical perspective. We find that price thresholds or important resistance levels are like a rusty door that requires several attempts before it finally swings open. As a result, while 2013 will likely be an up year, similar to what we saw in 2012, because of the expected increase in volatility we believe 2013 will be quite different from last year.

In 2012 the S&P 500 endured three days of in which the 500 declined by 2 percent or more versus an average of 15 such declines per year since 2000 and 21 days in 2011. So should there be a reversion to the mean
in terms of volatility, be prepared to fasten your safety belts.

H.L.: The S&P 500 rose in February rather than its typical decline. Can we read anything into that?

S.S.: Yes. Since 1945 there have been 26 times that the S&P 500 gained in price in both January and February. In each one of those 26 years the S&P posted a positive full-year total return, including dividends, averaging an advance of 24 percent and posting full-year results that were in single digits only twice - 1987 and 2011. The reason for this full-year early warning signal in my opinion is that investors, like an octogenarian willing to skip their cherished afternoon nap, believe there may be too much to miss should they take their traditional seasonal fiesta.

H.L.: What's the effect on the U.S. economy of the divide between Republicans in Congress and the president and the Democrats?

S.S.: History says, but does not guarantee, that equity markets record subdued annual performances under a split Congress. Since 1900, whenever there has been a split Congress the S&P 500 rose at an average of 3.8 percent per year versus 7.6 percent whenever the executive and legislative branches were dominated by the same party. I think this general under-performance is because Congress ends up impeding rather than leading.

H.L.: What do you think the U.S. economy will do this year and next year?

S.S.: Our expectation is that the U.S. economy will grow by 2.7 percent in 2013 and 3 percent in 2014. So even though this economic expansion is likely to witness an elevated trajectory, it can still be described as only a half-speed recovery. Unfortunately, our expectation is that it will remain a below-average recovery for the
next couple of years.

H.L.: Do you see any progress on jobs in this environment?

S.S.: Our expectation is that the unemployment rate will average 7.5 percent in 2013 versus 8.1 percent in 2012, but should creep down to an average 6.8 percent in 2014. One good thing is the recovery in housing in that every new home adds three new jobs. But obviously we are still rising from a very weak level of new homes constructed, so by itself housing will not turn the economy in general or the employment picture in particular any time soon.

H.L.: Can the housing market keep recovering?

S.S.: Yes. In 2012 we had an average of 780,000 housing starts, which we think will be 1.1 million in 2013 and 1.4 million in 2014. Yet, that is obviously, still quite a bit lower from the peak of the prior housing boom.

H.L.: What about Europe, which seems to be continuing to have debt problems?

S.S.: Europe sounds like a neglected middle child screaming for some renewed attention. It certainly got some in a negative way in the form of Italian politics with no clear majority arising from the most recent elections. Either a coalition will have to be formed, or the country will have to go through another round of elections. Right now, the existing parties are attempting to form a coalition, but the jury is still out as to whether they will be successful. The implication is that the third-largest European economy could waver in its austerity efforts to reduce its debt, which could reignite a worry of default contagion.

The European Central Bank is only willing to assist those countries that have adopted an approved austerity plan. So, should the new government decide not longer to adhere to its earlier austerity agreement Italy might be left dangling in the wind.

H.L.: Are you at all optimistic about the global economy?

S.S.: Based on economic projections by IHS Global Insight that all developed-nation and emerging market economies will be recovering from their Gross Domestic Product troughs, as a result our expectation is that for much of 2013 the components of the global economy as well as the overall economy should be experiencing a sequential improvement in quarterly growth.

Disclosure: I am long AAPL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.