“Investors are fearful of further falloff that may morph this pullback into a correction, bear market or mega-meltdown,” S&P Capital IQ’s Sam Stovall writes in his latest commentary. “At the same time, they are fearful of reducing their equity exposure and altering sector weightings only to miss out on an impending recovery.”
After a brief history of recessions since 1945, Stovall notes that today, “we believe investors are worried more about the discord than the decline.”
“Investors look to Europe and wonder when and how the discord on debt will finally be resolved,” he wrote. “This month’s Greek elections were swayed by austerity fatigue, while recent German elections have been influenced by bailout fatigue. It now appears to us that the Greeks are playing 'chicken' with the other eurozone countries, believing it’s worth bluffing for better terms. Indeed, since austerity and default are equally painful, the Greeks may have already come to the conclusion that default will end up being a cheaper and quicker solution to their debt problems.”
Stovall (left) is of the opinion that a Greek default or exit from the euro would trigger consequences that would lead to global bank failures and renewed recession. As a result, he says logic would dictate that Greek politicians become more centrist in their thinking before the situation deteriorates further.
“Yet we believe the inability of global equities to mount more than an intra-day counter-trend rally, combined with the ongoing decline of oil prices, and the seemingly endless drop in U.S. Treasury and German bund yields to historically low levels, speak to the massive risk that the contagion is likely to spread.”
So what should investors do?
“It has often been said that the greatest profits are made when blood runs in the streets,” he wrote. “Therefore, those with high risk appetites may be willing to nibble on the near-term opportunities that history and technicals say may soon arise. One approach is to search among those left for dead. Indeed, the sectors and sub-industries with the worst performances during sharp market declines typically perform best during the recoveries. In other words, the worst shall be first.”
He notes that from the S&P 500 recovery high from April 2 through May 18, the energy, materials, financials and information technology sectors have fallen by more than 11% each. Indeed, a few of these groups peaked well before the index did and are now far below their 200-day simple moving averages.
“Probabilities favor a near-term recovery that may offer tasty morsels for investors with high-risk appetites to nibble on,” he wrote. “Should this decline be just the start of a new bear market, however, we will need to endure a lot more time and tide before it finally ebbs. For investors with low-risk appetites, recent polls indicate that it may be too risky to assume that cooler minds will prevail.”
Read 10 Signs of a Springtime Stock Slump: LPL's Kleintop, on AdvisorOne.