Interview With Sam Stovall: Stocks Will Correct If Soft Patch Lingers Too Long, But 3% Growth In 2014

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

Harlan Levy: Do the recent spate of negative data - consumer sentiment in April at the lowest level in nine months, producer prices dropping the most in 10 months, oil prices down on lower demand, and flagging retail sales - indicate a faltering U.S. economy?

Sam Stovall: I think we are at least going through a soft patch in U.S. economic growth, that, if it lingers long enough, could serve as the catalyst for the long-awaited correction in equity prices.

Since last summer, investors have been expecting an increased trajectory in U.S. economic growth, and through February the data has proven right. Yet to paraphrase Dinah Washington, what a difference a month makes. And I believe that this soft patch is attributable to higher income taxes, cooler temperatures, as well as increased negative rhetoric regarding a dysfunctional Congress and the still-unresolved sequestration and debt ceiling.

H.L.: How much of an effect are the sequestration cuts and the 2 percent payroll tax hike really having?

S.S.: I don't have any hard numbers to point to, but I believe that the news of cutbacks, whether they relate to White House tours, the Blue Angels military acrobatic aircraft team, or the limited state park availability, has had a depressing effect on consumer confidence and has therefore likely spilled over into retail sales, consumer confidence, and other economic indicators.

What Wall Street needs to find out, however, is whether the sequestration and payroll tax hike are more than just a one-quarter phenomenon.

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

S.S.: S&P Economics is still projecting a 2.7 percent increase in Real GDP for all of 2013, with growth above 4 percent in the second half and growth of 3.1 percent for all of 2014.

These numbers indicate, however, that U.S. economic growth is likely to remain below average and is vulnerable to any negative downdrafts emanating domestically or internationally.

We continue to believe that the Federal Reserve will maintain its stimulative approach as deflation remains a concern based on the recent Producer Price Index report and weakening energy and metals prices.

H.L.: Now that it's earnings season, what's ahead and what's underlying corporate performance?

S.S.: S&P Capital IQ reports that consensus estimates point to a 0.7 percent increase in year-over-year operating earnings for the S&P 500 in this first quarter of 2013. Sequentially, this growth is one tenth of the growth seen last quarter. Yet it's hard not to expect the final number to be higher by a few percentage points, as companies continue to demonstrate their ability to manage analysts' expectations.

Case in point: At the beginning of the fourth-quarter reporting period, earnings were expected to rise 3.6 percent, but they advanced 7.7 percent. This quarter we expect earnings to be up by 3 or 4 percent, rather than the current estimate of less than 1 percent.

H.L.: Was the drop in jobless claims part of a trend, or is the jobs situation stuck and going nowhere?

S.S.: The jobless report seems to be headed in the right direction, but for the wrong reason, meaning that the unemployment rate continues to creep lower but only because the participation rate has slipped as well. We believe that part of the reason for the decline in the participation rate is the retiring of baby boomers, as well as existing workers filing for disability and long-term job seekers giving up in frustration.

Should the trajectory of the global economic recovery finally begin to elevate, we think that companies will be forced to increase hiring rather than hours worked. But only time will tell.

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

S.S.: The S&P Case-Shiller 20-city home price index is up more than 8 percent year-over-year even though we are still down more than 29 percent from the mid-2006 high. Our belief is that home prices will continue to rise since inventories remain relatively lean, and consumers' wealth effect has been rising due to improving equity prices.

As a result, S&P Economics projects residential construction to rise 19 percent this year and nearly 23 percent next year.

H.L.: A lot of conservatives think gold is the safest investment, but these days that's not the case. Are they delusional?

S.S.: Gold has historically been considered a store of value, yet, as any investor can tell you, based on recent fluctuations, it is not an investment recommended for the faint of heart or weak of hand. The only thing that makes me feel encouraged about gold is how much it is universally despised at present. So, from a contrarian perspective, if you have not sold your gold already, you might be better off just holding on to it. With interest rates still at or near historic lows, the cost of carry remains close to zero.

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

S.S.: I think consumers and investors are becoming desensitized to the drama in D.C. Ever since the rally after the presidential election the market has pretty much ignored the fiscal cliff, the delay of the debt ceiling, the sequestration, and the postponement of a continuing resolution to keep funding the U.S. government. I think investors are much more focused on the expected health of the U.S. economy generally and the expected growth in earnings in particular.

H.L.: What about Europe and its reappearing debt problems?

S.S.: The ongoing flare-ups of the European debt situation remind me of seismic aftershocks following a major earthquake. They have become annoyances rather than reasons for panic.

From an investor perspective, a boxer is rarely felled by a punch he or she expects. I believe that which will eventually derail this ongoing advance in equity prices will likely be something we have not been worrying about during the past three to five years.

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

S.S.: Yes I am, but optimistic with a lower-case "o." I believe the trough quarter for a majority of developed nations and emerging markets is already largely behind us. As a result, we believe that global growth will continue to improve in the quarters ahead but probably at a more muted pace than investors would prefer.

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.