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 getmarketscope.com.
Harlan Levy: What do you think of this wild stock market, with its triple-digit ups and downs, and is a summer correction coming?
Sam Stovall: It's interesting how investors continue to measure volatility based by hundred-point moves in either direction for the Dow when each hundred-point move represents less than 1 percent. A better gauge would be how many 1 percent decline days we have experienced as compared with what is more normal. Thus far in 2013 we have had on an annualized basis fewer than half of the average number of decline days since 2008.
From May 21 through June 24 the S&P 500 has already gone through a nearly 6 percent price decline. I call price declines of 5 to 10 percent "pullbacks" and declines of 10 to 20 percent "corrections." So we have already entered into a pullback stage. Now the question is how deep does it end up going. Our belief is that if this pullback does get any deeper it will remain a pullback and nothing more, and while the market may end up tracing out the design on Charley Brown's shirt over the next couple of months, we still believe equity prices will be higher at year-end than where they are at mid-year.
H.L.: Now that the second quarter has ended, what do the earnings of the various sectors look like?
S.S.: The second quarter, S&P Capital IQ consensus estimates point to 3.3 percent increases in operating earnings for the S&P 500, with six of the 10 sectors expected to post increases led by double-digit gains forecast for consumer discretionary, financials, and telecom services.
At first glance, one might think that earnings-per-share growth is slowing. But the S&P recorded a 5.2 percent earnings increase for the first quarter. Also, heading into the first-quarter reporting period, consensus estimates called for only a 0.5 percent increase in first-quarter earnings. In fact, the ending gain was within the historical 4 to 5 percentage point range above which actual earnings have come in compared with original estimates.
In other words, historically, the actual earnings have come in anywhere from 4 to 5 percentage points higher than the original estimates. So if this were to continue, or hold true for the second quarter of this year, we would expect to see actual earnings to advance anywhere from 7 to 8 percent.
There is one fly in the ointment, however, and that is that top-line growth - sales or revenues -- remains a concern. Revenues were expected to rise by 4 percent in the first quarter. Yet they actually came in only half a percent higher. For the second quarter, revenue growth looks to be as challenging as it was in the first quarter, as the S&P 500 is expected to post only a 0.5 percent gain.
Some common tail winds to second-quarter earnings will come from easy year-over-year comparisons, the low-interest environment, and the continued gradual improvement in the overall economy. Common headwinds include the uncertainty surrounding the impact of tax increases since the beginning of the year, the sequestration, a 1.6 percent average increase in the value of the U.S. dollar, and a 1 percent climb in oil prices during this quarter versus the year-ago quarter.
H.L.: So what kind of growth will the U.S. economy have this year?
S.S.: S&P Economics for the second month in a row reduced its full-year Real Gross Domestic Product forecast to 2.4 percent growth in 2013 as a result of the delayed conclusion of the sequestration. We now believe it will likely be resolved some time in the third quarter, if at all during this calendar year. As a result, we have reduced our second-half annualized GDP growth from more than 5 percent down to something closer to 4 percent.
H.L.: Has Congress's failure to make fiscal policy that deals with unemployment and the deficit hamstrung the economy?
S.S.: Because the revenues have been going up, as a result the deficit has been coming down, so in some ways one could say that the sequestration has been doing what Congress has not been able to agree to do. Therefore, the Fed has been required to use monetary policy as a way of supporting and stimulating the U.S. economy, since we're not getting much leadership from the fiscal perspective.
H.L.: One of the concerns that Wall Street is wrestling with right now is the tapering off of the Fed's $85 billion-per-month bond-buying program.
S.S.: If economic growth continues to recover as the Fed expects, they told us in no uncertain terms that they would likely begin tapering by the end of 2013 and complete the tapering by the middle of 2014. Wall Street, in our opinion, seems to have the September meeting fixed as the time at which the Fed will start its tapering program, while we believe it is more likely to be in December. Because the government will still have to deal with the sequestration and the resolution to continue funding the its operations by September, and also because we believe the Fed will require several months of improving economic data, we believe the Fed will start its tapering in December.
H.L.: Is any of this a surprise?
S.S.: The Fed's tapering of the bond-buying program is not necessarily a new event for investors to consider, because the Fed was not going to be buying these bonds forever. As a result, this market is going through a metamorphosis of being a liquidity-driven rally to a fundamentally driven one.