S&P Capital IQ Equity's Sam Stovall shares both his short-term and longer-term outlook for the stock market.
Sam, we have had an enormous run up in stocks since the mid-November low. How do you think 2013 is looking, and do you think stocks are getting expensive?
I think in the short term, we are probably due for some digestion of these recent advances.
What is interesting is somebody mentioned to me the other day, "Gee, we are already up 20% since the middle of November." I’m thinking no, no, your memory is like mine when I try to describe my grades in college; they weren’t that good.
We have been up about 11%—not 20% since mid-November, but still a very good run. But when you think about it, we have had either a pullback (a 5% to 10% decline) or a correction (a 10% to 20% decline) every year since World War II—and it has taken us only two months on average to get back to breakeven after pullbacks and only four months to get back to breakeven after corrections.
So my feeling is if you then say OK, well what about valuations...are we really overpriced? Are we really expensive? Not really. We are about 15% below the average P/E since 2000, and I’m leaving out all of the 1990s. Since this secular bear market started, we could see the S&P 500 at 1,740 if we simply went back to the average P/E of 16 times projected 12-month earnings.
Is that the forecast you would give us in this interest rate environment, where interest rates matter?
Interest rates do matter. Right now, S&P Capital IQ's year-end target for the S&P is 1,550, which you could think is almost like saying, "Gee Sam, it sounds like you are bearish because we are so close to that."
Well, we established this target on November 26 for the full year of 2013. So yeah, the market has done better than we thought it would, but let’s also remember there is a relatively high wall of worry out there.
We were exceptionally lucky last year with a lack of volatility. We had only three days in which the S&P fell by 2% or more, and normally we have 15 days per year—and in 2011 we had 21.
So I think we have become at least a bit too complacent in terms of volatility, and we probably will end up having that pullback, maybe even a correction a little later this year, and possibly 1,550 won’t be such an underwater target as it appears it might be so far.
So the low interest rates will allow the market to trade at higher multiples. How large do you expect the swings to get in 2013? Would 15% surprise you?
I think a 15% decline would be a lot. I just realized I didn’t finish your full question about interest rates. No, that’s a very good point, because some people worry that we could go back to a single-digit P/E environment. I remind them that going back to 1953, we would need to have the yield on the ten-year note be above 7% in order to justify a P/E of 11 or lower on the trailing 12 months.
So when interest rates are this low, and assuming they stay within a half or even 1% of where they are in early 2013, how high could the multiple get?
Well, take that one step further. If you say I really don’t even believe interest rates because I think the fed is manipulating the interest rate environment, then let’s look to inflation, because inflation really drives interest rates in this kind of an inflationary environment at 1.5% to 2.5%.
We are trading right now at a 15% discount to the average multiple, and the market typically rises at least 10% in 12 months after we have had such a low inflationary environment.
What is the probability of that 10% rise in that environment?
Probably very high—more than 80%. Obviously it is not 100%; there is no guarantee.
When did it not do that? In what years did it not rise by 10% when you had this big of a discount?
Umm, there I have to go back to the memory banks on my computer. The rolodex isn’t...
It is very rare, it is obviously very rare.
It is very rare.
15% of the time.
So the feeling is that we are undervalued whether you look to projected earnings or whether you look at trailing earnings. We are undervalued if you look to the inflationary and interest rate environment that we have now, so if you can stay the course through this volatility, you will probably be rewarded.
One last question: where are our earnings for 2013 for the S&P 500? What is your projection? I know we have the blue chips...
The S&P Capital IQ consensus number is about $112 per share for the S&P 500, or about a 9.5% increase.
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