Equities: Time to buy or bail?

Although markets were up during the first quarter of 2012, unabated volatility continues to leave investors undecided whether it’s time to buy or sell.

Sam Stovall, chief equity strategist at Standard & Poor’s, looked at historical trends to put things in perspective at the annual Investment Management Consultants Association (IMCA) 2012, in National Harbor, Maryland.

“Going back to WWII, whenever the market was up in both January and February, it was up for a full calendar year,” he said. “That’s important because February is the second worst performing month for the S&P 500, after September.”

This has happened 25 times since WWII, with the average total return, price plus dividends, being just above 24%.

There’s no guarantee, though, that 2012 won’t be the first to break that trend. Stovall agrees, but says the theory is not without merit.

“[For one,] some would say we are in the very beginning of a brand-new bull market,” he said. “The S&P only fell 19.4% on a closing basis last year [meaning] we didn’t slip into the official bear market of 20%. Also, the world is not dominated by the S&P 500 the way it used to be.”

Stovall asserted there are compelling reasons to go back into stocks—one being improving global data.

“The U.S. is moving further away from a double-dip recession,” he said. “We’re by no means growing at a gangbuster pace, but we’ve still got a half speed recovery.”

Also, a lot of investors are starting to believe China, despite evidence of a slowdown, will successfully engineer a soft landing. Things in Europe, too, aren’t turning out to be as hopeless as feared.

“Investors are starting to feel a little bit more confident that we would not see a Lehman-like repeat when LTRO [long-term refinancing operation] came into effect in early December,” he said.

The jury’s still out on future implications of LTRO, but for now it’s helped soothe investor nerves, said Stovall while admitting some problems do remain.

“Who knows what’s going to happen in the Middle East,” he said. “The expectation is that possibly we could see Iran mine the Strait of Hormuz, even though the U.S. mine sweepers have been able to clear that area. But there’s still some uncertainty investors would rather not have to deal with.”

In the U.S., potential for higher interest rates has become a growing concern. Stovall said many investors have taken Bernanke’s recent remarks to Congress to mean “maybe we won’t see rates at zero through the end of 2014.”

Still, Stovall’s research shows whenever bond yields start rising, equities do better. And that, he said, forms a compelling case for remaining in, or moving back into, equities.

“When interest rates were in an upward trend, and they moved into the 4% zone, equity prices actually started to do better on a monthly basis,” he said. “Possibly because bond investors who started to feel the seesaw effect—as rates rise, prices fall—are now looking for a new home for their money.”

Volatility may pick up and markets may sag during the course of the year, but investors should hang in there. A correction, says Stovall, is no reason to bail.

“[Investors feeling] scared because the markets are picking up in volatility, and would rather bail out, are going to miss out on the great opportunities that the market has to offer,” he said. “We’ve had 86 times since WWII that the market declined by 5% or more; in 83 of these times we’ve recovered everything we’ve lost in a median of 14 months or fewer.”

History, he said, can serve as virtual valium for those losing sleep over market gyrations.

Back to the Expert outlook: Analysis from 2012 IMCA and CFA conferences Report