With Sam Stovall, Chief Investment Strategist of U.S. Equity Strategy at CFRA
Sam Stovall, Chief Investment Strategist of U.S. Equity Strategy at CFRA, stopped by to discuss the ongoing government shutdown.
The Shutdown And The Stock Market
Observing that there have been more than 20 government shutdowns in the U.S. in the last 40 years, Sam said the shutdowns end up being good headline events but don’t really affect overall bottom lines, citing the overall static price performance of the S&P 500 during the shutdowns. However, Sam added that the stock market and the U.S. credit rating might look worse if the shutdown drags into March 2019.
Interest And Earnings
Switching topics to interest rates, Sam pointed out that while most people had anticipated the 1 percent rate hike in December 2018, the announcement that more increases would be on the way in 2019 did cause concern. Some relief occurred when Fed Chair Powell decided to wait and see how the economy reacted in the next year. More rate hikes could lead to negative investor responses, so Sam feels this is a positive thing.
Sam estimated that overall earnings projections currently stood at 5.8 percent, down from his initial assessment of 6.1 percent. The falling percentage, taken in tandem with Wall Street analysts reducing full-year estimates every two or three years, may have investors worried about a downward shift in earnings growth.
With the average rate of earnings growth standing at about 8 percent a year since the late 1980s, Sam explained the S&P 500 typically reports in the mid-to-high single digits on an annual basis. Factoring in an average of 8-percent growth in common stocks with the added dividend of 2 percent, the total return comes back around 10 percent over a long period.
S&P And Normality
Pointing to the S&P 500 rising or falling by 1 percent more than 64 times in the last year, Sam noted 2018 seemed volatile since 2017 only saw about eight changes, resulting in complacent investors getting caught off guard by the 2018 changes.
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Steve Pomeranz: I’m very happy to bring back my next guest. His name is Sam Stovall. He’s Chief Investment Strategist of US Equity Strategy at CFRA and a longtime veteran of the market. Welcome back, Sam.
Sam Stovall: Happy to be here, Steve.
Steve Pomeranz: I was looking at your notes dated January 9th and you talk about three things we want to discuss today. The first is the government shutdown. Now, by the time this airs, the government shutdown will probably be over. Hopefully, it’ll be over. But we want to get some context to this because it’s probably going to happen next year or the year after. So tell us a little bit about it that over the past 40 years, whether these shutdowns have had any material impact on the markets.
Sam Stovall: Well, first off, I was very surprised that we’ve had as many as we had. In the past 40 years, there have been more than 20 government shutdowns. But what is most interesting, however, is that they end up being good headline events but not really affecting overall bottom lines. I say that because when I look at the price performance of the S&P 500 from the start until the end of these government shutdowns, the average decline—or I should say the average change—has been none, meaning it’s been flat.
No change between the beginning and the end on average. At worst, in 1979, we were down a little more than 4%. But the best, believe it or not, is today, that basically the market has been higher by more than 6% since this government shutdown on Friday, December 21st. So I would tend to say, unless it does actually go into March, unless we do find that ratings companies downgrade US debt, so forth and so on, only then do I think that this government shutdown will be a problem for the stock market.
Steve Pomeranz: Yeah, I think the real news to me, it was that the first one happened in the mid-70s, and I thought this was a 1990s phenomenon but it’s really not. Really surprising.
Sam Stovall: No, it’s not. And actually, I can’t guarantee, that the first one was in the mid-70s. That’s just as far back as my source went.
Steve Pomeranz: Okay, but even that going back that far says a lot. All right, well interesting. Let’s talk about interest rates. Because the Fed did change their position or their language or shifted their languages as you write. And tell us a little bit about that.
Sam Stovall: Well, when they did announce policy after the December meeting, at which they raised interest rates by one-quarter of 1%, pretty much as most people had anticipated, the statement that they made really sort of threw the market into a tizzy tailspin. Because they had said that they were in a sense on autopilot and that they were just going to continue to march along in 2019, raising rates by as many as four additional times and then possibly one or two more times in 2020.
The market pretty much felt that with the prospect of a peak in corporate profits, that slowdown in the year-over-year growth of the US economy, as well as a pretty shaky Chinese economy, that maybe the Fed should be holding back, embrace a more dovish tone, but they didn’t get that. So when we did have the release of the minutes most recently from that December meeting, in many ways they did sort of confirm what Fed Chair Powell had said a week earlier. In that, they’re more willing to be patient, to look, not only at the economic data but also, in a sense, be swayed by how investors are taking the news. Because a negative investor response could end up being a self-fulfilling prophecy.
Steve Pomeranz: Right, exactly. I guess there was a certain tone deafness to the statement of the previous statement. And I guess they learned really quickly because [LAUGH] they’ve realized they made a mistake because the markets did not like that one bit. That’s not to say that the Fed is being controlled by the markets or by the administration, but it has to be sensitive to these kinds of things as well. And because, really, the future is uncertain, they don’t really know for sure. But it did look like in the 3rd quarter, that things were really starting to heat up in the economy and interest rates were rising and inflation was, I think, starting to show some signs of rising.
Oil prices were very high there for a while. But needless to say, all that changed. I want to talk about earnings. Because to me, the most important factor in investing in stocks is earnings, whether you buy an individual company or you buy a broad index like the S&P 500. It’s earnings which creates the wealth in these corporations, which creates the higher stock prices that we all hope to achieve in the future. So what are the earnings expectations now going into 2019?
Sam Stovall: Well, into the full year of 2019, S&P Capital IQ consensus estimates—so that’s basically scooping up all of the Wall Street analysts and coming up with an aggregate number—are now thinking that earnings will be up only 5.8% which is actually down from yesterday’s note that I wrote in which I said, it will be up 6.1%. So every time we seem to be updating the numbers, they come in a little bit softer. This is a bit unnerving because as of the end of 2018, the full-year earnings were expected to be up 6.5%. And as of the end of the third quarter of last year, September 30th, earnings were expected to be up 10%. So we went from 10 down to 6.5, and here we are today at 5.8, which is not a good trend.
Steve Pomeranz: Yeah, so that may say something about stock prices for 2019? That was a question.
Sam Stovall: Yes, absolutely. Because, first off, on average, meaning about two out of every three years, Wall Street analysts end up reducing their full year estimates as compared with what the estimates were at the beginning of the year. And on average, that reduction has been equal to five and a half percentage points. So what that means is that, okay, if we started the year at six and a half, take away five and a half, that means we probably could end up with only 1% earnings growth for all of 2019. So maybe that’s what’s causing investors to be worried because of the downward shift in earnings growth.
Steve Pomeranz: Sam, what is the average rate of earnings growth going back in history?
Sam Stovall: It’s about 8% per year, that’s operating earnings going back to the late 1980s. And then something called GAAP, which is Generally Accepted Accounting Principles, or what some others call as reported earnings, going back to the mid-1940s. So, in general, mid to high single digits is what the S&P 500 will report on an annual basis.
Steve Pomeranz: So kind of in theory and in general, if earnings for the broad base of common stocks in the country are growing over time on average of 8% and you add a dividend of 2% or more to that. You’re talking about a total return of somewhere around 10 or 11%. Have we basically seen that?
Sam Stovall: Over the long haul, yes, we have. So you’re bringing up a good point because why do people invest? They want a cut of the action. What is the action? The action is earnings.
Steve Pomeranz: Yeah.
Sam Stovall: And you receive those earnings in the form of price increases, share buy-backs, or dividends. And so, yes, over time you can see that investors have been rewarded through earnings increases and dividends.
Steve Pomeranz: Yeah, that’s the thing for long-term investors to keep their eye on. That’s the horizon that you’re looking at to your destination instead of watching the lines going by in the road and looking at all the short-term noise that happens. Keep your eye on the horizon, and this is a good statistic to kind of remember to stay stabilized in that idea. Before we run out of time Sam, I want to talk about volatility. You write that the S&P 500 rose or fell by 1% or more in 2018. Rose and fell by, rose or fell by 1% or more in 2018 64 times. How does that compare to the average?
Sam Stovall: It’s a lot, not a lot higher, it’s a bit higher than the average. But back in 2017, we were up only 8 times seeing that kind of volatility. So we had 8 times that amount in 2018, the average going back to 1950 is around 50 times per year, the average since 2000 is closer to 70. So I think one reason that investors feel that 2018 was such an incredibly volatile year is that they had been lulled to sleep in the year before, and now we’re really just getting back to what has been normal.
Steve Pomeranz: It’s normal. So that is all based on how you feel. If you’re sitting in a lake and the water is warm and you expect it to be warm, next time you go in it’s cold. It may be just a little bit colder, but it feels like a shock because you got used to the warm water. That was a terrible metaphor but I’m going to stick with it.
Sam Stovall: [LAUGH] Okay.
Steve Pomeranz: [LAUGH] My guest is Sam Stovall, Chief Investment Strategist of US Equity Strategy at CFRA, and he comes on from time to time to tell us about the market. And, hey, if you have a question about what we’ve just discussed or got a money issue on your mind, ask us and join our conversation. And contact us through our website which is stevepomeranz.com. And while you’re there, sign up for our weekly update. It’s a rundown of important topics that we’ve covered this week and a long history of past segments and commentaries. And you can contact us through that site and through that page as well. The update goes straight into your inbox. We’d love to hear from you. Visit us at stevepomerance.com. Sam, thanks so much for joining us today.
Sam Stovall: My pleasure, Steven.