Sam Stovall Is Bullish With a Lowercase 'b'

CFRA's Sam Stovall joined TheStreet's Conway Gittens on January 7th to discuss Sam's forecast for 2025.

A few highlights:

• Stovall estimates a 7% return for the S&P 500 in 2025, to 6585.
• Expect more volatility this year. Trump is a shortened word for “uncertainty”
• The S&P 500 is overvalued. Earnings will have to grow for a rally to be sustained.
• The Fed will raise rates 2x in 2025, with the first occurring no sooner than March.
• Trump policies could benefit small caps more than large.
• Sam has some specific investing suggestions, including…
• Holding last year’s winners but adding some defensive names.
• Basic Materials may be ready for a bounce relative to the SPX
• Plus quality dividend payers.

Enjoy the video above and the transcript below.

Conway Gittens: Sam Stovall is chief investment strategist at CFRA Research. Thank you for coming, by TheStreet, Sam.

Sam Stovall: Good to talk to you again, Conway.

Conway Gittens: All right. Sam, so according to the Stock Trader's Almanac, if Santa Claus should fail to call, bears may come to Broad and Wall. So Santa Claus didn't show up this time. So, what does that say to you about the possibility that this stock market is running out of steam?

Sam Stovall: Well, that certainly is a possibility. But when you look at such a short-term indicator, which is really only seven trading days, what it shows is that whenever Santa Claus does fail to call, the market still has risen by an average of about 6%. But did so only one in three times. So, in a sense, it makes for a more challenging year ahead. Also, they have the first five days of January and what does that imply for the full month? But I actually prefer to look at the January barometer also from the Stock Trader's Almanac. As goes January, so goes the year, because looking at first year of presidential elections, looking at their first year in office with a positive January, the market gained a little more than 18% and rose in price 91% of the time. Whereas on the flip side, if it declined, then the market was off by 2% and falling in two out of every three years. So short term indicators are interesting. But I think the longer term the January barometer is more reliable.

Conway Gittens: So how are you feeling heading into January. Given the strength that we saw in 2024 and then the kind of weakness that we saw at the tail end of the year, what does that mean for what could happen in January?

Sam Stovall: Sure well, I think what it means is put on your reality cap that we're probably not going to have a three peat because going back to World War two, whenever we've had two double digit gains in succession after a down year, we only 1 and 5 times have we then had a third year in which we were up by double digits. Also going back to World War two, year one of presidential cycles have seen 90% of them have seen 5% declines or greater in that first year, with the average actually being about 17% So volatility could be on the ascent. I remind investors, however, that declines of 10% to 20% have taken about four months to get back to break even. So while a 17% decline might sound pretty significant if we get that out of the way before the end of July, typically we're in a positive scenario by the end of the year. So I like to call myself a bull, but with a lowercase ‘B.’ And I think that the market could end up with a mid to high single digit return for all of 2025. So the S&P 500 was up more than 24% in 2023, then up another 23% in 2024.

Conway Gittens: What does that mean for the momentum in 2025? You mentioned this inability for a 3 peat. And I'm really thinking about this, especially given the fact that we have not had a meaningful correction since I don't know when.

Sam Stovall: Well you're absolutely right. We did have two pullbacks last year. We had a 5.5% and an 8.5% decline. But Yeah meaningfully I think we needed something more like a 10 plus percent decline. But we didn't necessarily need a new bear market. So nobody has repealed pullbacks corrections or bear markets. So we will get one. The real question is, will it be happening in the coming year. One of the concerns I have is that traditionally third years of bull markets are pretty challenging of the 11 bull markets since World War two that celebrated their second birthday, three of them became new bear markets before the year was out, two more posted declines, even though not enough to become new bear markets. And then three additional ones ended up with returns of 6.5% or less. So a majority of those year twos were, in a sense unsuccessful. And so I think that there's a good likelihood that we have a pretty challenging year 3 and we're also starting the year with pretty stretched valuations in my opinion. 2024 was the year where the stock market almost went straight up, right. And so in 2025, what do you think we'll see in terms of volatility. We will see more of a choppy year. I think we probably will end up seeing more of a choppy year. Historically, the first and the third quarters are relatively flat in terms of price change, but obviously still maintaining that elevated level of volatility. The second and fourth quarters tend to be posting higher returns. Also, in the first year of a president's term in office, we've had 90% of those years in which there was a decline of 5% or more, and many of them have been above 10% So I think volatility is something investors will have to get used to in the year ahead.

Conway Gittens: And so besides volatility, what are some of the biggest risks that could derail the stock market in 2025? I think I looked at your S&P 500 target is 6585.

Sam Stovall: That's right. My expectation was that we would end 2024 at 6145. I was a bit too optimistic. And based on that 6145 2024 target, I said, I think the market will go up about 7% in 2025. And that's how I came up with the 6585 number. I'd rather lean toward the high single digit number, but I don't feel like making an actual change to the target price itself. One of the concerns that I have is valuations. When you take a look at the S&P 500 and you look at the PE on forward earnings estimates right now trading at about 23 times, that is a 20% premium to the average over just the last 10 years. And it's a near 40% premium to the average over the last 20 years. So the market is pretty expensive, priced to perfection and therefore vulnerable in my opinion, to any negative exogenous event. The only problem is that unanticipated events are hard to anticipate. So I'm not sure what would cause the market to go into a tailspin.

Conway Gittens: So I don't like to put words in my guest mouth. But if I understand you correctly, you're saying that earnings have to be perfect, or the earnings season has to be perfect in order to match the expectations that's already baked into the market for 2025.

Sam Stovall: That's right. Yes, Perry Mason would have objected with your leading the witness, but I think you did a good job. Essentially, what it means is that in 2025, we'll probably not see a PE multiple expansion, because it's already expanded quite a bit that the price appreciation will really be dependent upon earnings growth, which right now is pegged at about 12.8% for the S&P 500 25. And if we do not get any additional disappointments coming from the Fed. So I think very important will be earnings growth and the possibility that the Fed will be cutting rates by at least two more times.

Conway Gittens: So you brought in the Federal Reserve. Let's talk about them because we're already starting to get not new data in terms of 2025, but end of the year data for 2024. And it looks like the economy, at least on paper, ended off on a stronger note than most people expected. So what does that mean for your expectations for the Federal Reserve in terms of how many rate cuts we get, and how does that impact your view for what happens to the broader market?

Sam Stovall: Well, the economy has been stronger than anticipated, and the employment picture has been more resilient than many had anticipated. Our expectation is that in the end, the real GDP will grow by 2.8% in 2024, and our forecast is a 2.4% rise in 2025. It had been 2.5% but it's been brought down a little bit because of the worry about tariffs. I think a lot of companies had been accelerating their orders in order to get them from overseas suppliers before tariffs possibly went into effect. So a moving forward, if you will, of GDP growth of expenditures, et cetera, which could end up taking some from the growth expected for 2025. Our belief is that because the economy will look pretty strong, the Fed is going to take their time. They're going to wait until March, possibly before the first of two rate cuts in 2025, or maybe even wait until later in the second quarter as we start to get additional GDP data that shows that indeed, the economy is slowing. And that it was more of a flash in the pan in Q4 of 2024. Employment data is also going to be quite important, and our belief is that when we get the report for Friday, maybe we see the unemployment rate tick up to 4.3% And Yes, we'll probably get nonfarm payrolls coming in a little weaker than last month. But I think the Fed's going to wait for more data before making a decision as to when they will cut once again. So now included in your risks are possible risks to the outlook for the stock market.

Conway Gittens: You left out one important five letter word or five letter name goes by the name of Trump. And so factor in how the President-elect could impact your outlook for the market in 2025.

Sam Stovall: Well, you're absolutely right. Trump is a shortened version of the word uncertainty, because we're not certain whether his comments about tariffs are a negotiating ploy or something. That is just going to happen the day that he takes office. The hint was the other day, the Washington Post. I mean Yeah, the Washington Post said that it's probably not going to be a truism that it is more likely a negotiating ploy. However, the President-elect then responded quite quickly that no, it is not just a ploy. And here's another example of fake news. So I think we have to take the President-elect at his word and that tariffs really are something that would take place possibly. Therefore, that could be a catalyst for the mid and small cap stocks, which obviously have greater exposure to domestic marketplaces rather than international markets. They will be less affected by tariffs, less affected by the strength in the value of the US dollar. But that could end up causing the 10 year yield to remain elevated and maybe even climb a little bit higher. Also, I think that while we could see some benefits from lower tax rates on corporations and on individuals, as well as drill, baby, drill pushing down the price of oil, which would help consumers at the gas pump that what could happen is that does, again, elevate the amount of debt that the US has to take on. And so as a result, that could put a pretty firm floor underneath the 10 year yield and act as a drag on economic growth.

Conway Gittens: Now, Sam, I know you're a strong studier of history. And you talked a little bit earlier about what happens in the first year of a presidential term in terms of the stock market. I'm wondering, since President Trump is in his going to be in his second term, but it was divided by someone else's term. Does history say anything about what could happen to the stock market in the second term of a president when it's divided by somebody else's term?

Sam Stovall: Well, we don't have any data that goes back that far. Grover Cleveland was the only president before President-elect Trump to have that happen. And he was in power before the Dow even came out in 1896. So, no, we don't really have any easily available data that would help to tell us that. We pretty much have to look at, well, what typically happens in the second term of a president's eight years in office unless the president decides to try to change the 22nd Amendment, this will be his last four years in office. So essentially with a lame duck, if you will, somebody who's not going to be running once again, the returns are less strong than they are in the first four years of their term in office, but still can be pretty good in the first year, relatively weak in the second year, strongest by far in the third year, and then good, but not great in the fourth year. So I think we have to wait to look at inflation data, interest rates and corporate profits to really know whether history will repeat. Or like the singer of the National anthem. Forget the words.

Conway Gittens: So you mentioned your S&P 500 target. What are some of the most attractive sectors on Wall Street right now?

Sam Stovall: Well, what's interesting is that history, I have a lot of investors ask me at the beginning of the year, should I buy last year's winners or last year's losers. And history says that depends. If last year was a down year, you want to own last year's losers. But if last year was an up year and 2024 was an up year, you tend to do much better by letting your winners ride. So since 1990. If you owned the top three sectors in equal amounts in the coming year. That had been the best performers in the prior year, you would have beaten the market 75% of the time, and would have outperformed the market by about 300 basis points per year. So pretty good outperformance. So with that in mind, you would want to hold on to communication services, consumer discretionary and technology. But I also add the fact that if you are a bit nervous about technology because tech has posted gains in excess of 30% in six of the last eight years. And if you worry, gee, maybe I should add a little bit of defensiveness to my portfolio. Not a bad idea. A portfolio of 50% tech, 50% consumer staples since 1990 has returned 94% of the return of tech alone, but with 40% lower volatility. So for investors who are getting a little bit nervous, this could be a good way of helping them to sleep better at night.

Conway Gittens: What about basic material?. That was the only down sector in 2024. If we are taking the flip side with history encourages us to let your winners ride. Do you let your losers lose?

Sam Stovall: Yes essentially you do. I was looking at the rolling 12 month relative strength charts that I create for materials, for consumer staples and for health care, and they've all done quite poorly, but they are at very low extremes, more than one standard deviation, if not two standard deviations below the mean. So if you are a believer in reversion to the mean, they could be good opportunities to start to nibble. I wouldn't back up the truck because historically, it takes quite a while for underperformance to really become outperformers because there's an awful lot of overhead resistance. James O'Shaughnessy, in his book What Works on Wall Street, shows that you're better off sticking with high momentum than low momentum areas. But when things have been beaten up that badly, it would be good to start thinking about cherry picking in materials, consumer staples, and health care as potential longer term opportunities.

Conway Gittens: So if you could invest in one ETF in the new year, which would it be?

Sam Stovall: Well, that's a good question. I would tell you that I would probably want to have some exposure to the US stock market, because I still believe that's going to be the better area. But I'd want to take on a bit of defensiveness, if you will. I want to go for the higher quality stocks that pay a dividend, that have also increased their dividends in each of the last 25 years as a minimum. So an ETF like noble Nobel, which is the S&P 500 dividend aristocrats. I don't own that ETF, but its sister ETF, which is the high yield dividend aristocrats, ticker SDY. So therefore I'm one who likes to look for companies that have high quality and high consistency of growing both earnings and dividends.

Conway Gittens: All right Sam, what is your wild card for 2025?

Sam Stovall: The wild card is that it starts to benefit the economy much sooner than investors anticipate, and that we end up with another double digit gain in 2025, driven quite a bit by technology. And those three outperformers from 2020 for semiconductors are expected to post a 45% increase in earnings in 2025. 38% is expected in the fourth quarter. The earnings period just about to start to be reported, and if we end up with continued strength in that area, that certainly is a wild card and something that investors would hope for. But I wouldn't necessarily bet the farm on.

Conway Gittens: Before I let you go, how about a US recession. How much of a wild card is that in terms of 2025?

Sam Stovall: A US recession or just an economic downturn. Well, we've had a lot of indicators, such as the inverted yield curve. The leading economic indicators year on year posting a decline in earnings, recessions. Many of those things have happened over the past three or four years that did not turn into a recession, and that usually does. Now, we are in an improvement of the employment situation as well as a re correction, if you will, of the yield curve, which also has traditionally preceded recessions. But our expectation is 2.8% growth for 2024, 2.5% 2.4% growth for 2025, and 2.2% GDP growth for 2026. So we think that a recession has been delayed, but it's certainly not been repealed.

Conway Gittens: All right. Great tips from Sam Stovall, Chief Investment strategist at CFRA Research. You've been watching us here at TheStreet