The equities market and stock exchange traded funds are recovering. While some have reservations on the extent of the recovery, the stock market may still has legs.
S&P 500 index-related ETFs, including the SPDR S&P 500 ETF (NYSEArca: SPY), iShares Core S&P 500 ETF (NYSEArca: IVV) and Vanguard 500 Index (NYSEArca: VOO), gained about 1.9% this year after rising 14.4% since its February 11 low.
While pessimists point to a variety of headwinds that could slow the recovery, more optimistic observers counter with “yeah, but…” evidence to the contrary, Sam Stovall, U.S. equity strategist for S&P Global Market Intelligence, writes in a note.
For instance, pessimists are pointing out that the bull rally has experienced a seven year run, which is just shy of only one of the 11 completed bull markets since WWII, the Tech Bubble that experienced an eight year bull. However, bullish sentiment only sours when people believe a recession is imminent, but the S&P’s economic forecasts call for a 2.3% in real gross domestic product, with unemployment dipping to 4.6% by year end and improvements in consumer spending, housing starts and consumer confidence.
Some worrywarts are also concerned about the ongoing earnings recession in the S&P 500, with some projecting a 8% decline in first quarter earnings per share. However, investors should keep in mind that the earnings decline is largely due to the drag in the energy sector, which experienced a 60% decline in EPS for 2015 and is projected to record a record 70% decrease this year. Excluding energy, the S&P 500 earnings would have been up 6.8% in 2015 and could rise 3.1% in 2016.
Observers also argued that recessions since 1948 were were preceded by a 10% or more decline in the S&P 500, which is worrisome since we just saw a 14.2% drop earlier this year. However, the market tends to be overly cautious and anticipated 32 of the last 11 recessions – for investors, this means that not all corrections and bear markets lead to recessions.
[related_stories]Heightened valuations has also been a point of concern for many equity traders. However, valuations need to be considered in relation to inflation. Given the core CPI rose 2.2% since March of 2015, today’s General Accepted Accounting Principles price-to-earnings of 20.4X is currently 8% below the average during prior low levels of inflation since 1958. Stovall also pointed out that the S&P 500 typically returned an average 6.5% in the following months whenever inflation was this low.
Federal Reserve interest rate normalization has also weighted on the equity outlook. However, S&P 500 dividend yields of 2.2% remain well above 1.77% yield on benchmark 10-year Treasuries. Since 1953, the S&P 500 has expanded an average 19% in the following 12-month period when the dividend yield of the benchmark index was above 10-year Treasury yields, posting a positive return 80% of the time.
Market traders are also growing cautious ahead of the seasonal “sell in May” mindset. Stovall, though, warned investors against trying to time the market. Alternatively, the strategist suggested investors may consider “rotating rather than retreating” during this typically challenging period.