Sam Stovall is chief investment strategist at CFRA, an independent eqity research firm. Previously he was U.S. equity strategist at S & P Global.
Harlan Levy: What do you think of the post-election stock market?
Sam Stovall: The post-election stock market is what I call the "Trump bump." Investors really just drove up stocks because they were so heavily expecting a Democratic victory that they were anticipating additional regulatory pressure put on financials, price controls placed on pharmaceuticals and biotechs, higher taxes pretty much across the board, combined with a mandated increase in the minimum wage.
When the opposite occurred, and the Republicans were voted in, there was a 180-degree turn, and investors flocked to financials, supported the healthcare and consumer discretionary categories, and, in a win-win situation, industrials, because of the prospect for increased infrastructure spending.
That's a win-win situation because the likelihood of infrastructure spending would have occurred under either party winning the presidency, plus it would be brought down to the state level, where the representative, be he or she a Democrat or Republican, could take credit with their constituents.
H.L.: Will the uptrend continue?
S.S.: The right answer is that it depends on the time frame you're speaking of. In the coming 12 months, absolutely. I think the S&P 500 closing at 2,186 says we can see the S&P 500 close in 2017 around the mid 2,300 area, which would represent about a 7.5 percent price appreciation, not a great year, but not bad year either.
Analysts have a hard time knowing what earnings will be for the next quarter, so at the risk of being really wrong I would prefer not going out further than a year. Strategists are like nighttime drivers who only drive at the speed that they can see with low beams on.
H.L.: What sectors are strong now?
S.S.: We are also in the cyclical six," the six months of the year in which the S&P 500 has done substantially better than in the sell-in-May period, which ends in October.
For instance, since 1945 the S&P 500 has risen an average of 6.7 percent November through April versus a gain of only 1.4 percent from May through October.
Interestingly, those performances have been replicated going back to 1990, which is as far back as S&P has sector-level data.
Even going back to 1990 those performances are still the same, 6.8 percent for the cyclical and 1.5 for the defensive six months, but in the November-through-April period the outperforming sectors, not surprisingly, have been the cyclical sectors, which include consumer discretionary, industrials, materials, and technology.
H.L.: So what do you think of the U.S. economy and its prospects.
S.S.: I like the prospects better than the current reality. Economic growth is expected to remain in the "terrible twos." We expect economic growth to hover between 2 and 3 percent in each of the coming four quarters. If President-elect Trump is able to pass infrastructure-spending bills and succeed in lowering the tax rate on repatriated earnings, I think investors are of the mindset that we could see an improvement in these forward estimates.
H.L.: What do you see for China and Trump's possible trade war?
S.S.: I don't see Trump becoming his own Smoot-Hawley tariff. I believe that his rhetoric will not become reality, that his bark is worse than his bite, mainly because I think he is a negotiator. Traditionally, when management and employees start negotiating they're usually pretty far apart, announcing hard-line stances that they know are going to end up being softened.
As a result I don't think he is going to alienate the two biggest trading partners from consumer discretionary perspective, plus since consumers represent more than two-thirds of our overall economy, I don't think anyone wants to start the first year of a new administration by shooting themselves in the foot.
H.L.: What's happening with bonds?
S.S.: The bond market has thrown a variety of people for a loop, with the 10-year yield approaching 2.3 percent. On the one hand that's good for banks, because the widening yield spread improves net interest margins, yet, like the old image of the see-saw, when yields go up, prices go down.
The real question is whether this is a sustainable trend or is it just a knee-jerk reaction to the surprise Trump election. I think it's a little bit of both. The economy is likely to be improving over the next several quarters, which is one reason why the stock market has treaded water over the past year, rather than decline substantially, despite elevated valuations.
So, interests are likely to be advancing, but I don't think the parabolic near-trend rise is anywhere close to being sustainable.
S&P Global Economics believes that the 10-year note will probably rise to around 2.4 percent late in 2017, but this is after undulating between 1.9 up to this 2.4 percent level along the way.
Inflation is not something we see picking up dramatically. We think Core CPI is likely to remain in the low 2 percent area throughout 2017. So we don't see a lot of upside pressure on the 10-year note.
H.L.: What about pressure on the Fed?
S.S.: The Fed is putting pressure on themselves to raise rates, because they want to recalibrate the relationship between inflation and the Fed funds rate. Normally the effective Fed Funds rate is 1.4 percentage points above the year-over-year change in Core CPI, which, if all things were equal, would require the fed funds rate to be closer to 3.7 percent, rather than the current 0.37 percent.
The Fed wants to insure that they have enough arrows in their quiver with which to fight the next recession.
H.L.: When might the recession occur?
S.S.: No clue. We are currently in the 89th month of the current expansion, which is more than twice as long as the average expansion since 1900. I look to housing starts, consumer confidence, and leading economic indicators for clues as to when the next recession might hit. None of these indicators is in negative territory, yet, traditionally, a 30 percent year-over-year decline in housing starts, combined with a 20 percent year-over-year drop in consumer confidence, plus a negative six-month change in leading indicators is needed before a recession can strike.
None of these indicators is yet in negative territory, let alone at extreme negative levels. Again, I can't go much longer than a year and what I see is no recession on the horizon.
H.L.: What does history tell us about the market's performance in the year of a Republican term in office?
S.S.: Good question. I always like ending on a sour note. Since World War II we have had five Republican presidents, and four of these five saw the market decline in their first year in office, with the market off an average of 2.7 percent for all observations.
This compares quite unfavorably with a near 14 percent rise for the first year of Democratic administrations with an 83 percent frequency of an advance.
One reason for the poor Republican showing could be that every Republican president since Teddy Roosevelt has experienced a recession in their first term in office, and all but one since Roosevelt experienced a recession in their first two years in office.
Does that mean that Republicans are poor managers of the economy? I think that we need to look more closely at the business cycle as well as the Fed to understand why we had recessions when we did, not based on who is the president. One reason is that the market has done twice as well under Republican-controlled Congresses than under Democratic-controlled Congresses. So, in other words, here is another example of using statistics to tell whatever story you want.
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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.