Each week, we tap the insight of Sam Stovall, Chief Equity Strategist for S&P Capital IQ, for his perspective on the current market.
EQ: Since stocks hit their high in mid-September, the sentiment seems to have been leaning towards the bearish side. Has the decline over the past month been as bad as the bearishness has made it seem?
Stovall: I don’t think so, because from Sept. 14, which was the peak of this recovery high, until Oct. 12 the S&P 500 had fallen only 2.5 percent. Yet, people were talking as if it were the beginning of something much deeper. My feeling was that they should at least wait until the decline is actually meaningful before starting to worry. I think declines are meaningful once they eclipse the 5-percent decline threshold, or what I categorize as a pullback. A decline of 10 percent to 20 percent is a correction, and a decline in excess of 20 percent a bear market. Any decline between 0 percent to 5 percent is just noise because it happens on such a regular basis. Of course, the closer we get to 5 percent, the louder the noise. But we’re only down 2.5 percent and people are worried about the next Armageddon, and I think they’re overdoing it.
EQ: Could that be partly due to a lack of a perceived catalyst now that QE3 has been announced?
Stovall: Yes, I think that’s a good point. What caused investors to begin to feel optimistic in the early part of June was that the European Central Bank would attempt to do whatever it could to support the euro, and the U.S. Federal Reserve would likely introduce QE3. Now that both of those anticipated events have occurred, investors understandably are left wondering what they have to look forward to. Well, I think what we have to look forward to is the possibility that the third quarter is likely the trough in corporate earnings. So we have to be, borrowing an old phrase, looking forward to the green shoots of economic activity, implying that we are not heading back toward recession. We also have to look forward to the results of the upcoming election, as well as the possible resolution of the fiscal cliff.
EQ: In this week’s Sector Watch, you used the Fibonacci retracement tool to help determine where the S&P 500 could pullback to. Can you tell us about the tool and what you found using it?
Stovall: Fibonacci was an Italian mathematician from several hundred years ago, and a Fibonacci retracement level represents a percent giveback of the advance from a pivot low to the recent recovery high. So for instance, the S&P 500 bottomed on June 1, 2012, then recorded a recovery high through Sept. 14 of 14.8 percent. If we look at the first Fibonacci retracement level, representing 26.6 percent of that recovery, which means that the S&P 500 would go from 1466 down to around 1421. The second level would be around 1394. Our chief technician Mark Arbeter believes a retracement to the first Fibonacci level is likely all that we will see.
EQ: Looking at the sector performances since the summer lows, only two sectors have hit official pullbacks and another one just about there. The other seven have not. What does this tell us?
Stovall: It tells us that not all sectors move to the same beat and that not all sectors take an equal length of stride. During this most recent recovery, the best performing sectors were Telecom Services, which gained 27 percent, and Energy, which gained more than 22 percent, versus the sub-15 percent advance of the S&P 500. On the flip side, those groups that still rose, but not as strongly as other groups, were Consumer Staples up 10 percent, and Utilities, which was up 11.5 percent. So in my report, I showed where the S&P 500 and sector indices stood on Oct. 12, and where where their the next lower Fibonacci retracement levels. This gives investors an idea of how far these indices would still need to fall before we could move higher, and basically an idea of the potentially negative case scenario to what might happen to them.
EQ: You also quoted Mark Arbeter in the report with three reasons why a break below the low is potentially a good thing for bulls. So could it actually be more beneficial for bullish investors over the longer term to root for pullback to break to lower lows?
Stovall: Being of bullish mind at this point, he believes that based on the patterns and trendlines that he has been mapping out, the S&P 500 would likely approach the 1600 level by the end of this year or beginning of 2013. So as a result, he regards any pullback as a buying opportunity. Similar to the stretching of a rubber band, he believes that the further the market declines before it resumes its upward trend, the greater the launch, if you will, as a result of that decline. So his feeling is that should the S&P 500 go lower than he initially thinks, then the decline would embolden the bears to push some of the sentiment indicators to bearish extremes, which would be bullish from a contrarian perspective. So people are being overly concerned, which represents a good thing, because from a technical perspective, it would set us up for an even nicer launch over the next several weeks and months.
EQ: In a way, is that like a mini capitulation?
Stovall: Yes, pretty much so in that it shakes off the loose hands and allows the market to reset itself and then work its way higher.