Home Radio Segments Guest Segments Will February’s Market Volatility Derail The Rest Of The Year?

Will February’s Market Volatility Derail The Rest Of The Year?

Sam Stovall, Market Volatility

With Sam Stovall, Chief Investment Strategist of U.S. Equity at CFRA

Due to unusual market volatility over the last few weeks, Steve decided to bring in a market expert to make sense of it all.  His guest, Sam Stovall, is Chief Investment Strategist of U.S. Equity at CFRA, a leading investment research firm that was acquired by S&P’s Equity Research Department in 2016.  Sam views markets through a lens of history, valuations, momentum, and other relevant market moving factors.

Extraordinarily Low Volatility Compared To Historical Averages

Sam notes that U.S. equity markets have been characterized by unusually low volatility over the past few years even as stocks soared to new highs in 2017—with over 60 new all-time highs, well above historical averages. At the same time, there were only eight days in the year when the market was up or down by 1% or more, which was well below the average of 50 days per year of 1% market volatility since World War II.  So, the market’s been awfully bullish and highly stable, from a historical perspective.

In addition, market history suggests that years of record new highs and low volatility are typically followed by a return to average volatility in the second year, and Sam believes the bout of market volatility in February 2019 is reflective of past trends.

Don’t Convert Paper Losses Into Real Losses

So, with markets swinging wildly in February 2018, Sam recommends staying invested if you don’t need the money for the next few years.  He cites the Crash of 1929, where investors only lost money if they sold at depressed values but did okay if they stayed invested.  More recently, in the 2007-2008 bear market, the S&P 500 lost almost 60% of its value, but investors who stayed in got back to breakeven in just four years. Sam recommends staying invested through downturns, without making the emotional mistake of turning a paper loss into a real one.

Cues From Calendar Year Seasonality

In addition, Sam believes market seasonality matters.  For instance, January is usually a good barometer of what will likely happen in the market for the rest of the year: As goes January, so goes the year.  And Sam believes this true for both the market as a whole and for sectors and sub-industries within the S&P.  He also notes that when investors drove shares higher in January, markets gained about 11.5% in the remaining months of the year, 85% of the time. So, with markets up in January, there’s an 85% chance stocks will rise for the rest of the year.

S&P 500 Up In January 2018

With the S&P 500 up 5.6% in January 2018—7% above its 50-day moving average and 14% above its 200-day moving average—Sam expects a reversion to the mean, potentially through a 560-point drop in the S&P 500, from its January high of 2,873, down to about 2,535.

What Next?

With the bulls and bears duking it out right now, no one can predict what might come next.  A 5% correction off of recent highs would be deemed a pullback, likely to be followed by a rising market.  A 10%-20% drop would be viewed as a long-overdue correction.  And a drop of 20% or more would indicate a bear market.

Moreover, as Steve has pointed out several times, the deeper the decline, the greater the percentage to get back to the break-even point. For instance, if you lose 5%, it only takes 5% to get back to break even. If you lose 50%, it takes 100% to get back to break even.

With rising market volatility, expect to see wild swings in your portfolio, but don’t let your emotions get the better of you.  If you need the money over the next few years, now might be a good time to get out while the market’s still ahead.  If you don’t need the money, ride this one out with the expectation that January 2018’s market rise should take your portfolio higher over the next 12 months, with a fairly high 85% probability.

Disclosure: The opinions expressed are those of the interviewee and not necessarily United Capital.  Interviewee is not a representative of United Capital. Investing involves risk and investors should carefully consider their own investment objectives and never rely on any single chart, graph or marketing piece to make decisions.  Content provided is intended for informational purposes only, is not a recommendation to buy or sell any securities, and should not be considered tax, legal, investment advice. Please contact your tax, legal, financial professional with questions about your specific needs and circumstances.  The information contained herein was obtained from sources believed to be reliable, however their accuracy and completeness cannot be guaranteed. All data are driven from publicly available information and has not been independently verified by United Capital.

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Steve Pomeranz: Due to the unusual market volatility of the last few weeks, I’ve decided to change things around a little bit and bring in a market expert. If you follow this show, you know this gentleman. He is the chief investment strategist of CFRA. He’s a regular guest on the show. He takes an historic approach to the market, focusing on market history, valuations, momentum, and other things like that.

CFRA is an independent equity research firm which was acquired by S&P Equity Research Department in 2016. I mention it because Sam is well-known in the industry for being affiliated with S&P Equity Research. All that said, I’d like to welcome Sam Stovall to the show. Hey Sam, welcome to the show.

Sam Stovall: Hey, Steve, good to talk to you again.

Steve Pomeranz: Let’s get right to it. We’ve had in one way a very unusual type of volatility. We had all of this low volatility for so long and market experts have been talking about it. I know that I’ve been talking about it with clients. Everybody has been feeling that it hasn’t been quite right. What kind of context can we put this, the low volatility, in first before we get to the high volatility?

Sam Stovall: You’re right. 2017 had two things going for it. First off, we had more than 60 new all-time highs, which was twice the average for any year that had at least one all-time high. At the same time, we only saw eight days in which the market was up or down by 1% or more, as compared with an average of 50 every year since World War II.
What I found out was that in the years following such high number of new highs and low volatility, volatility actually got back to the average number in that second year, so we’re actually seeing history repeat itself because volatility has most definitely picked up early in this new year.

Steve Pomeranz: What’s breathtaking about it is that it seems to have picked up in like three seconds flat, you know? There wasn’t any real warning. I think some of it has to do with the fact that markets … There’s a saying that markets rise in a stair step fashion, but they go down in elevator fashion. Perhaps the reason is that fear is a stronger force on our behavior than greed. Any comments on that?

Sam Stovall: I absolutely agree. I actually believe that adrenalin enhances memory retention. That’s why we remember where we were when tragic events occurred, and that’s what the financial media tries to instill in viewers every day. So, when these financial shows say, “The world is coming to an end tonight at midnight. Tune in tomorrow to see if it really did,” they just want to maintain the viewership by creating some sensational commentary, and I think that is human nature to be drawn to that.

Steve Pomeranz: Yeah. And I think when you see the market down a lot you get that kind of terrible feeling in your stomach, like an elevator going down too fast, and you kind of wonder where is it ever going to end, or is the elevator going to kind of crash on the floor and it’s all over, I’m going to lose everything? I am sure in your statistical analysis if people stayed put there really isn’t any evidence that they crash and burn to zero?

Sam Stovall: Exactly. Even in the great crash of 1929, you only lost money when you sold. The market did not go to zero. In fact, the most recent bear market in which we lost almost 60% of the S&P 500’s value got back to break even in only four years. Even somebody who retired on the day that the market peaked has 20 years to live in retirement, and therefore the first four years, they’re just waiting to get back to break even. If you don’t have four years, then you should not be invested in equities. But still, don’t make the biggest emotional mistake of turning a paper loss into a real one.

Steve Pomeranz: Okay. That’s exactly what my experience and my studying in the market has shown, and you’re seeing the same thing in you’re a statistician. So, let us take a look at what just happened. Now, this is going to be aired the week of the … yeah, the week after next, basically, Valentine’s Day, let’s put it that way. So, as a Valentine’s Day present to all of you, we’re going to talk about how terrible the market was in the weeks following January. First of all, let’s talk about January. This is what’s so weird. January was a fantastic month surprisingly.

Sam Stovall: Well, January is usually a very good barometer as to what is likely to happen for the remainder of the year. If you’ve ever subscribed to the Stock Trader’s Almanac, you do know the old saying that “as goes January, so goes the year”. Both Gail and Jeffrey Hirsch are friends of mine, and I took that advice and took it one step further, and found that it even works for sectors and sub-industries within the S&P. It’s a very good indication that if investors are willing to pile into the market in January, we have had about an 11-1/2% price gain in the remaining months of the year, along with a batting average of about 85% of the time the market went up in the remaining 11 months of the year after it posted a positive January.

Steve Pomeranz: Calendars are in a sense fictitious. They’re just, you mark one day and then you mark another day and then you build a system. The world revolving around the sun doesn’t really care about it so much, so January seems a little arbitrary, especially considering that just a week later pretty much all of January’s gains were wiped out. Where does that put us?

Sam Stovall: I agree with you that you could say that it’s really more of a continuum than a calendar, but businesses work on the calendar year, or a lot of them do, and they enact their budgets in January. Also, pension funds tend to add money to their portfolios in the beginning of calendar years. Usually we wait to see February in terms of bonuses, and we start to max out 401ks early in the year. That’s why the old adage of “sell in May” takes place, in my opinion, is because of a lack of capital inflows after a lot of money has moved into the markets in the first four and five months of the year. So, yes, I still believe that there is some effect from the calendar, and that’s why seasonality is not something to be ignored.

Steve Pomeranz: Okay. How far ahead of itself when you look at these moving averages, and you’re looking at historic rise or fall in the market and then you see, hey, the stock price went way above that average … How far above that moving average did the S&P get in January?

Sam Stovall: It got 7% above its 50-day moving average and 14% above its 200-day moving average. Please excuse my nerdiness right now, but both of these measures were more than one and a half standard deviations above the mean, or in other words, pretty rare occurrences and levels of excess that really had to be worked off either in time or price change. What we found was it had a big impact in price in a very short period of time.

Steve Pomeranz: Yeah. So, it came right back down to the averages, would you say?

Sam Stovall: It came down to the 50-day moving average. Actually, both the Dow and the S&P broke below their 50-day moving averages, which is what I think contributed to the mass selloff, the 1,000-point decline, mainly because it then triggered sell stops for investors who had been riding this bull market upward and kept elevating the level at which they want to get out in order to lock in profits. But we’re still well above our 200-day moving average.

Steve Pomeranz: All right. So, the 200-day moving average, not to get too nerdy, but this is a more serious number because it takes into account more time, so if the market would continue to fall, where is that 200-day moving average number?

Sam Stovall: If the market were to continue to fall, or at least go down to that 14% decline threshold, it would be around 2,535 on the S&P 500.

Steve Pomeranz: What does that mean for the average viewer? Where is the S&P now?

Sam Stovall: What that means is that from the January 26th high of 2,873 it would be about a 14% decline, or a mid-level correction, but certainly not the beginning of a new bear market.

Steve Pomeranz: Okay. Good question there. So, we’re still within the framework of a bull market? What number … is there such a thing as a number … but where would the market have to go to signal a change in direction to a bear market?

Sam Stovall: We would have to lose about 560 points in total on the S&P 500. We would have to lose 20% off of the most recent high, which was 2,873, because that is the definition, if you will, of a bear market. Now here is where you could be splitting hairs by saying, wait a minute, so 19.5% is a correction, but 20.5% is a bear market? The answer is yes, because humans are compartmentalizers. We like to put things into categories, mainly because like a pullback is 5 to 10%, a correction is 10 to 20%, and a bear market is 20% plus, first off because it’s easier to categorize them, but second, the deeper you go into a decline, the greater the percent change needs to be in order to get back to break even.

If you lose 5%, it only takes 5% to get back to break even. If you lose 50%, it takes 100% to get back to break even. So, I think that’s why we break them into those three categories, so that we have a better feeling for what is the magnitude of the following recovery that is needed to get back to the starting point.

Steve Pomeranz: Okay. Interesting stuff. But as of now we are still well in bull market territory. My guest, Sam Stovall, Chief Investment Strategist of CFRA. Sam, thanks for taking time to talk with us today.