Sam Stovall sees double-digit correction, says rally has gone too far
The rotation trade likely won’t save the S & P 500 from a double-digit correction ahead, according to Sam Stovall, chief investment strategist at CFRA Research. Stocks are undergoing a strange moment as of late. This year’s market laggards such as small caps have started to outperform after last week’s cooler inflation data and dovish comments from Federal Reserve Chair Jerome Powell strengthened the case for a September rate cut. The small-cap iShares Russell 2000 ETF (IWM) has jumped more than 4% just this week, and is up 11% this year. On the other hand, the mega-cap tech stocks have faltered. This year’s market darling Nvidia has tumbled 8% this week, and has plunged about 15% off its recent highs. IWM 1M mountain iShares Russell 2000 ETF (IWM) For many, the recent moves were a sign of a long-awaited rotation that could mean further gains for the S & P 500, as the market broadens out from the artificial intelligence trade. But Stovall is skeptical, saying he anticipates an S & P 500 pullback ahead, possibly in September, in the low double-digits. “I’m a little bit suspicious of how long this will last,” Stovall said in a phone call with CNBC. Expensive valuations Central to the strategist’s concern is the overbought nature of large-cap tech stocks. Stovall noted the S & P 500 is trading at a 37% premium to its average 20-year price-to-earnings ratio, but tech stocks — which have an outsized presence in the index — are trading at a 75% premium. At the same time, the relative strength of the cap-weighted tech sector compared to the equal-weighted sector has climbed to highs going back to 2000, he noted. “So, there’s an awful lot of stuff going on in the large caps that say they are very expensive,” he said. What’s more, he doesn’t expect small- and mid-caps will have the heft to lift the index if those large-caps falter, he said. Large caps represent more than 92% of the entire U.S. stock market, compared to 8% of the value in small- and mid-caps. “So, you think 92% is going to fit into less than 8%? I say that’s like thinking that you could drain one of the Great Lakes into your backyard swimming pool,” Stovall said. “Even the thought of that overwhelms me.” ‘Don’t back up the truck’ For investors, Stovall said the most ideal scenario for the S & P 500 would be a situation in which large-cap stocks go sideways, as small- and mid-caps outperform. However, he said investors should be prepared for a sudden downturn ahead. “If they have been contemplating taking profits in some large cap areas, meaning some stocks that they believe are fully valued or overvalued, take the profits while you can. Rotate into very attractive mid- and small-cap stocks or mid- and small-cap ETFs,” Stovall said. “But don’t back up the truck. Because in a declining market environment, there is almost no place to hide, meaning everything falls. They just fall by varying degrees,” he added.
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