Sam Stovall: 5 to 10 Percent Decline Possible, But Only a Pause on the Way Up

Sam Stovall is Standard & Poor’s’ chief investment strategist, as well as author of the new book The Seven Rules of Wall Street and the column “Stovall’s Sector Watch,” a page on www.businessweek.com. He is frequently quoted in The New York Times and the Wall Street Journal and often appears on CNBC and other business TV networks.

H.L.: Is the stock market facing the reality of the economy?

S.S.: That’s an interesting question. If the economic projections are correct, in which we only see about a 1.5 percent advance in Real Gross Domestic Product next year, and if the economists’ earnings estimates are right, then the market is getting ahead of itself.

But maybe the economists are wrong, and certainly every time we get new economic data, it comes in stronger than anticipated, and quarterly GDP estimates continue to rise upward. A case in point is that third-quarter GDP estimates only a few months ago were calling for a 1 percent decline in annualized GDP growth, but now the estimates of the experts are calling for an advance of 2.5 to 3 percent. So, maybe the question should not be “Is the market getting too far ahead of the economy?” but rather “Are the economists finally seeing it the way the market does?”

H.L.: Do you foresee more volatility ahead in the stock market and a big drop?

S.S.: I think volatility is now something that investors should expect. It’s more the norm going forward. From 1960 until 2007 we saw an average of only five times per year in which the S&P 500 declined by 2 percent or more in a single day. Since then we have averaged more than 10 times that amount.

I think that because of hedge funds, computer day-trading, and leveraged ETFs (Exchange Traded Funds), a higher level of volatility is likely to be a more normal situation.

That said, while we believe in the possibility of a 5 to 10 percent decline over the next several months, we believe that if it does occur, it would happen at a level of the S&P 500 higher than where we are now and would simply be a pause within a longer term advance in equity prices.

Looking at fundamental, historical, and technical factors, we point to the S&P 500 at 1,200 as the potential peak in this cyclical bull market.

H.L.: Federal Reserve Board Chairman Ben Bernanke declared last week that he favors a strong dollar, which tends to cause the stock market to drop. Is keeping a stronger dollar a good thing, and is it even possible?

S.S.: Instead of “keeping” a stronger dollar, I would say “hoping for,” since the dollar has been weakening over the last several years. And we think the dollar will continue weakening at least into 2011.

Certainly a strong dollar is a good thing when you have a healthy economy with low debt, but we have neither. As a result, a lower dollar will make our products and services more attractively priced in overseas markets and could end up acting as a tailwind for corporate earnings growth, as we estimate that as much as 50 percent of revenues for S&P 500 companies come from overseas.

H.L.: Earnings season is almost in full throttle. What’s your outlook?

S.S.: The S&P equity analysts forecast a 7 percent year-over-year decline in operating earnings for the S&P 500. At first glance you might think that’s a negative. However, compared with a 19 percent decline in the second quarter, a 39 percent decline in the first quarter, and a 101 percent decline in the fourth quarter of 2008 – this was the first time in history that the S&P posted a loss – then you get the true feeling that “less bad” is good.

What’s more, S&P forecasts an 11 percent growth in earnings for all of 2009 and a 34 percent advance in 2010.

H.L.: Jobless numbers are looking better, but continuing unemployment threatens to significantly shrink consumer spending, the biggest factor in the economy, even though the latest consumer confidence reading improved. What’s your outlook?

S.S.: We believe unemployment will move above 10 percent by the end of this year and remain above 10 percent throughout all of 2010. We also see unemployment remaining above 9 percent for all of 2011. So the unemployment rate will certainly be in the back of everyone’s minds as to what kind of psychological or real damage it could inflict on the consumer’s sentiment and habits.

But does that mean that high unemployment will short-circuit the recent stock market advance? Our feeling is no, that like the early 1980s and early 1990s a high unemployment rate will lead to a jobless recovery but will probably not throw it back to another bear market. A case in point is that the S&P 500 bottomed in August 1982, a month after the unemployment rate hit 9.8 percent. Equity prices rose more than 80 percent in the following 12 months, while unemployment continued to rise, hitting 10.8 percent --which was the highest since World War II -- remaining above 10 percent for nearly a year.

H.L.: What’s the most surprising or the most unpredictable thing about the economy and stock market that you’ve seen?

S.S.: The most surprising thing is the consistency to historical averages with which investors this time around anticipated the end of the recession as well as the prospective turnaround in operating earnings. In addition, I’m intrigued by the traditional recovery exhibited in which stocks have beaten bonds, small-caps have outperformed large-caps, and cyclical sectors have trounced defensive sectors. So, while it may have been an atypical bear market, it is turning out to be a typical recovery.

H.L.: What do S&P equity analysts currently favor?

S.S.: Currently we favor cyclical stocks over defensive issues in general and have overweight recommendations on the industrials, materials, and energy sectors, while recommending an underweight on utilities and telecom.

Comments

[untrusting ...:]

"Looking at fundamental, historical, and technical factors, we point to the S&P 500 at 1,200 as the potential peak in this cyclical bull market."
**********************...
Hmmmmm, Stovall must be looking at the same stuff the rating agencies looked at in rating all the securitized mortgages as AAA instead of DDD. Absolutely nothing in fundamentals or historical metrics remotely justifies SP1,200. In fact as pointed out by many other long-term market managers such as Rosenberg, Kass, Hussman, etc. fundamentals and historical metrics would point to an SP600-800 as the level justified for the current situation.

Interesting that Morningstar published today that in 2009 only $14.5 billion has gone into stock funds and $254.5 billion has gone into bond funds. That almost 20x the amount going into bonds as opposed to stocks. Insiders are selling at near record levels and insider buying is virtually non-existent. Corporate buybacks are at the lowest levels in years. Where's the buying coming from? NOT from retail investors as they are buying bonds, not from insiders as they are selling, not from the corporations as they have drastically reduced buybacks. Who's left?..... ohhhhh.... that would the prop.trading desks at GS, JPM, and a handful of HFT's that reportedly are accounting for 50-70% of all trading volume.

If Stovall were honest he would acknowledge that the recovery rally is due almost entirely to: 1) massive Fed liquidity, 2) hugh dollar declines/devaluation, 3) ultra low interest rates, 4) artifical market support by the prop trading desks and HFT.

None of those things have anything to do with fundamentals, economic recovery, past historical market metrics, or anything else that Stovall attempts to use as a justification.

Nobody knows how long TPTB can keept this recovery rally smoking along, but the odds and historical metrics heavily a major correction. The longer it takes to get there, the worse it will be and the quicker the fall will be.

Oct 14 10:28 PM

[cebu sun:]

"If Stovall were honest..."

Now there's a leap. He is with the Ratings Agencies who brought us the subprime mess and are now being sued. They have a mega- conflict of interest and have no business remaining as part of Wall Street.

Oct 15 09:05 PM