With Sam Stovall, Managing Director of US Equity Strategy at CFRA Research; CFRA analyst and publisher; author of The Seven Rules of Wall Street: Crash-Tested Investment Strategies That Beat the Market
Steve spoke with Sam Stovall, Managing Director of US Equity Strategy at CFRA, about the current state of the stock market. Sam has been a market analyst and investor for many years, so he’s a good source of information when the market ride gets a little rough. Sam’s also the author of the book, The Seven Rules of Wall Street: Crash-Tested Investment Strategies That Beat the Market. He and Steve discussed the various factors that make the market rise and fall and what we can expect the market to be doing in the coming months and years.
A Double Downer
Steve pointed out that we are all fairly well aware that 2020 has been, to put it mildly, looking pretty terrible so far. With abnormalities like the novel Coronavirus popping up, can we expect the rest of 2020 to be as terrifying, specifically when it comes to the global marketplace?
“This year is a little abnormal; we’re definitely off on the wrong foot,” Sam said. “I’m a big believer in historical precedence. Stock Trader’s Almanac taught us many years ago that, as January goes, so goes the year.” Historically speaking, Sam explained, when the market is down in January, it only gained about 1% for the remainder of the year. “And the market was up a coin toss of 54% of the time otherwise,” Sam continued. When you couple this information with the fact that the market was down in February, too, Sam explained, “That’s what I call a double downer; the frequency of advance falls to only 40%, with the average full-year price change being less than 5%. So, while this isn’t a guarantee of a crappy rest of 2020, it does imply that uncertainty and volatility will be the watchwords for the rest of the year.”
Steve noted that it’s not just the overall decline but the magnitude of the daily declines that are unnerving a lot of people. Sam acknowledged that some of what the market is currently experiencing is a bit out of the norm: “We reached a peak, an all-time high on the S&P 500, on February 19th. Then in just six trading days, the market fell by more than 10%, which is the swiftest peak to more than 10% drop since World War II.”
The Market Is Cyclical
The market is cyclical. Steve asked the question that many investors are desperate to ask: “With these horrific declines, can we expect to see rebounds of the same magnitude?”
According to Sam, there’s hope. He said, “Look, I’ve told investors time and again that unless you have a foolproof market-timing system, don’t try to time when to get out of the market. More times than not, you’ll end up getting back in at a price that’s higher than the price you got out at.” Sam also pointed out that in 85%+ of the times since WWII when the market dropped in excess of 5%, it got back to breakeven within an average of four months. He explained that “Opportunists take advantage of these price declines and jump right back in and push the market substantially higher. So, yeah, if we find that the decline that we just experienced is all that we’re going to get, we could be in new high territory by early in the third quarter.”
A Much-Needed Correction?
Not long ago, the market experienced something that Steve referred to as a “pure, washout panic moment”, a day when the market was down by a thousand points. It ended up closing down 300 points. “It’s funny how the market being down by only 300 points can feel like a relief; that’s how weird the market can get,” Steve noted. And according to Sam, this was an important turn of events.
Sam noted that this was a near-term bottom which would basically guarantee a reflex rally, but, he added that he wasn’t certain it was the absolute bottom. “We were so overbought that I’d say this was a correction in search of a catalyst; could the novel Coronavirus satisfy as being that catalyst?” What ended up happening in the next several days was a decline of more than 10%. Sub-industries reached levels that indicated an extremely oversold situation, with a large percentage trading below their 200-day moving averages.
“So, while it doesn’t feel good for any investor, maybe this was a much-needed market correction,” Steve observed.
Stocks And Bonds
Steve moved on to talk a bit about the remarkable happenings in the bond market. “The other aspect of this market move is the bond market move. We’ve seen the yield on US treasuries, as I speak right now, under 1%.” He asked Sam if he recalled what the 10-year treasury rate was in 2019. Sam answered, “We basically saw them in the mid-1% area and then fluctuating up toward the 2% area. But to see what we’re seeing now—rates near or even below 1%—is unprecedented.”
Steve then said, “Getting back to stocks with that in mind, how do you value a company when the discount rate, the rate that you’re using to forecast valuations, is almost zero? It’s like an infinite valuation. It creates this terrible distortion. And is it possible that we could start seeing negative rates in the US?”
Sam replied, “I think it’s possible. I don’t think it’s either likely or advisable because just take a look at the countries that have had negative interest rates and how it’s really done nothing for them. It hasn’t helped boost their economies.” He added, “I don’t think you want to go to an extreme on anything. Some people felt that what the Fed did recently, cutting interest rates between meetings by half a percent, really sent the wrong signal, like maybe they know something we don’t, that there’s something to be concerned with and that the economy is weaker than we thought. I sort of feel like the Fed sent a wrong message, and I definitely think that going to negative interest rates would send a wrong message.”
Steve basically agreed with Sam’s assessment of the Fed’s move. “Their fiscal policy isn’t changing, but the financial policy is changing with that reduction in interest rates. That’s going to make it easier for corporations to borrow money, so they can more easily smooth out their cash flows or take care of whatever else they want to. But, yeah, Sam, that’s a good point about what signal does that move really send. I mean, psychologically, especially with all this fear about the Coronavirus, it may serve as—at least temporarily—a boost for the economy and the stock market. But, as you said, I don’t think we want to see negative interest rates on Treasury bills.”
Unfortunately, at that point, Steve and Sam ran out of time. They’ll have to reconvene sometime in the future to take another look at what’s going on in the financial markets and try to discern the intentions—and the effectiveness—of the latest moves by Chairman Jerome Powell and the rest of the Federal Reserve Board.
Disclosure: The opinions expressed are those of the interviewee and not necessarily of the radio show. Interviewee is not a representative of the radio show. 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 the radio show.
Steve Pomeranz: I want to welcome back my next guest, Sam Stovall is managing director of US Equity Strategy at CFRA, and he serves as analyst, publisher, and communicator of CFRA’s outlooks for the economy, market, and sectors but more than that, Sam has been a market participant and analyst for many, many, many years, and I have him on the show quite often especially when we’re going through some unusual times. Welcome back to the show, Sam.
Sam Stovall: Happy to be here, Steven.
Steve Pomeranz: So, we are going through a period of worry. 2019 was a spectacular year for the stock market. This year seems like a terrible year, but in reality, what do you think? Is it kind of normal or is it abnormal?
Sam Stovall: Well, I think it’s a little abnormal in that we are certainly off on the wrong foot. As you know, I’m a big believer in a lot of historical precedence, and we looked to the performance in January, and we found that the market was down for that month. Stock Trader’s Almanac taught us many years ago that as goes January, so goes the year, and whenever the market was down in January, it gained only one and a half percent for the remainder of the year and was up a coin toss 54% of the time. Follow that up with the market being down in February, what I call a double downer, and the frequency of advance falls to only 40% with the average full-year price change being minus 5%. Obviously, that’s not a guarantee, but what it does imply is that uncertainty and volatility will be the watchwords for the year.
Steve Pomeranz: Well, it seems to me that it’s not only the decline we’ve seen but the magnitude of the daily declines that are so unnerving. Is that pretty abnormal too?
Sam Stovall: Yes, it is. Actually, the decline, we reached a peak an all-time high on the S&P 500 on February 19th. In only six trading days, the market fell by more than 10% which was the swiftest peak to minus 10% threshold since World War II. Add to that, the January barometer saying that whenever the market is down in January, the volatility, the number of 1% plus days, is higher by an average of 40% when compared with years in which the market was up in January.
Steve Pomeranz: So, these terrific declines, everybody hopes that we can see rebounds of the same magnitude. Is that something that we can expect to see as well?
Sam Stovall: Yes, I’ve told investors that unless you have a foolproof market-timing system, don’t try to time when to get out of the market because more times than not, you’ll probably get back in at a price that’s higher than where you got out. I then remind them that of the 85-plus percent times since World War II that the market fell by 5% or more, we got back to breakeven in an average of only four months. So it’s amazing the speed with which opportunists take advantage of these price declines and jump right back in and push the market substantially higher. So yeah, if we find that the decline that we just experienced is all that we’re going to get, we could be in new high territory early in the third quarter.
Steve Pomeranz: Yeah, so we’re talking maybe June if February 19th was the high and you add four months to that, we’re talking about mid-June, right?
Sam Stovall: Absolutely. Independence Day from this decline.
Steve Pomeranz: Can I hold you to that?
Sam Stovall: Yes. If this is the bottom then I will tend to say that-.
Steve Pomeranz: If it’s the bottom.
Sam Stovall: Chances are late June, early July, we’ll be at a new all-time high.
Steve Pomeranz: Now, we’re recording the show, we record one week early and then it airs the next week. But a few weeks ago, based on when this airs, we had one down day where the market was down a thousand points and it was just—I’ve been doing this for a long time—it felt like one of those pure washout kinds of panic moments because it was not the first time it had been down a thousand, and then it closed down about 300 which was like…it’s funny how down 300 can feel like a relief. So that’s how weird this stuff gets. But did you feel at that point in time that the market was so significantly oversold that that could have been a bottom?
Sam Stovall: Yes. At least, a near-term bottom that would then generate a reflex rally. I would not be honest if I said that I felt it was the bottom for this entire move. But there were a couple of things that cause me to say that we were so overbought and oversold that this was a correction in search of a catalyst and the Coronavirus satisfied that catalyst. What happened then in the next several days was that we declined by more than 10%; we saw the percentage of sub-industries within the very broad US stock market reach a level that, without getting too wonky, basically is an extreme oversold situation. The percentage of sub-industries that are trading below their 200-day moving average. Once you get to an extreme low reading, that implies that it’s been overdone. The baby was thrown out with the bathwater and that we’re likely to see an improvement in share prices. Ditto for the valuations for the overall market, the price to earnings ratio on forward 12-month earnings was at an 18 year high. Now we’re within single digits of the average over the last 20 years.
Steve Pomeranz: So maybe it was a much-needed correction though it does not feel good for any investor and investors have the worry that these things are going to continue because there is no certainty except to say that the economies themselves over time do grow and prices will reflect that growth on average. The other aspect of this market move getting away from the stock market is the bond market move. We have seen the yield on the US Treasury as I speak right now under 1%. Now, just by way of historically in 2019, it was one-and-a-half percent and one-and-three-quarters percent. Do you remember the numbers of the rate we saw on the 10-year Treasury back in 2019?
Sam Stovall: Yeah, we basically saw them in the mid-1% area and so then we’re fluctuating up toward the 2% area and so forth. But to see something near 1% or even below 1% is unprecedented.
Steve Pomeranz: It is. And so really getting back to stocks, I mean, how do you come up with an intrinsic value of a company when the discount rate, the rate that you’re using to kind of forecast valuations, is almost zero? It’s like an infinite valuation. It creates this terrible distortion. Is it possible that technically, we could start seeing negative rates in the US, do you think?
Sam Stovall: Well, I think it’s possible. I don’t think it’s either likely or advised because just take a look at the countries around the globe that have had negative interest rates and how it’s done nothing for them. If anything, it’s probably caused their investors to be worried thinking, well, gee, if they need to induce us so much to keep money out of bonds, what is that telling us about the health of our economy, et cetera? So, I think investors are more likely to put their money under their mattress, even though inflation is likely to eat away at it. So I would say that you don’t want to go to an extreme on anything. Some people felt that what the Fed did recently by cutting interest rates between meetings by one-half of 1% really sent the wrong signal that actually maybe they know something we don’t, that there’s something to be concerned with, that this economy is weaker than we are currently forecasting. And so, in many ways, I sort of feel as if it’s sent the wrong message as would negative interest rates.
Steve Pomeranz: Yeah. Because their fiscal policy is not changing, but financial policy is changing with a reduction in interest rates that’s going to make it easier for corporations to borrow, help their cash flows, and the like, but really, what signal does that send? But we also know that a lot of this is caused by the fear of the Coronavirus, and so, therefore, psychologically, it may have a boost. We are out of time. My guest is Sam Stovall, managing director of US Equity Strategy at CFRA. Sam, thanks once again for all your help.
Sam Stovall: Always a pleasure. Thanks, Steve.
Steve Pomeranz: Some of what we’ve discussed may be a little bit complicated. You may need some clarity. So, we invite you to write in and ask us some questions and also come to our website, which is stevepomeranz.com and while you’re there, sign up for our weekly update where we will show you everything that we’re doing the previous week with the actual audio transcriptions of the entire interviews or commentaries plus summaries and the like and some fun pictures as well. Remember, we love to get your questions and we love to answer them, so don’t hesitate to come to stevepomeranz.com and ask us your questions. That’s stevepomeranz.com.