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The ‘good news’ and ‘bad news’ about the stock market today: Strategist

CFRA Chief Investment Strategist Sam Stovall joins Yahoo Finance Live to discuss the state of the stock market, recessionary risks, rising interest rates, economic growth, and the expectations for third-quarter earnings season.

Video Transcript

BRIAN SOZZI: Markets are locked into the mindset. The US is poised to plunge into a nasty recession perhaps very soon as interest rates continue to climb. But is that the right call? Joining us now is CFRA chief investment strategist, Sam Stovall. Sam, always great to get some time with you. Really liked your comment in our Editor-in-Chief Andy Serwer's newsletter over the weekend on a little historical perspective on market sell-offs and economic growth. What does history say about the sell-off we're seeing here? How much longer do you think this can last?

SAM STOVALL: Well Brian, good question because history basically says that the good news is that no bear market decline that then recovered-- 50% of that decline then went to set an even lower low. And that's basically what we have seen since June 16. And we bounced off of the June 16 low last Friday. The bad news is that history is a great guide. But it's never gospel. So who knows exactly what is going to happen.

I think based on the lack of sub-industries within the S&P that are trading above their 10-week moving average at only 7% above their 40-week moving average, which is exactly equal to where we were on June 16, that implies that we probably could end up seeing a relief rally in the making. The only question is whether it is likely to be sold into, or the beginning of a new bull market. But history says we probably have more to go to this downside.

BRAD SMITH: What do you expect sentiment to be around a relief rally? And would it have this, what someone had described to us previously, a rip your face off rally-type tenor to it? And is that something that investors should even be banking on?

SAM STOVALL: Well Brad, I think that they shouldn't necessarily be banking on it-- maybe be aware of it. But as Brian was asking before, I think that this will be a bear market with a recession because every time that the year on year percent change in headline CPI exceeded 6.5% since World War II, we had both. And bear markets with recessions have ended up being deeper and lasting longer than those without recession-- average decline being 35%.

So I think that we'll probably end up seeing this bear market bottom at around 3,200, which would be a 33% decline, very similar to long term averages. PE ratios tend to fall by one third, which would bring us to about a 14.9 PE ratio, which, again, is consistent with history. Then I would be looking for a rip your face off kind of rally because typically, we see a new bull market be triggered within three months, and the average gain of 47% 12 months later.

BRIAN SOZZI: Sam, what we're seeing from the Federal Reserve in many respects is unprecedented, at least for people that have invested in the stock market in the past 10 to 15 years. But what the Fed is doing here, are they setting the stage for a lost decade for markets? And when I say lost decade, maybe we just see returns 5% either way, over the next decade.

SAM STOVALL: Well, I've lost my keys. And I've lost my wallet. But I've never lost my decades. So maybe we end up seeing that happen. We certainly had that in the early 2000's because we had the mega meltdown bear market of 2000 through '02, and '07 through '09. So just to have one decade reprieve, I think is a bit not nice for investors, if you will. So I don't think it's going to be a lost decade.

I do think, however, that your rolling 10 year compound growth rates do tend to moderate toward the 6% to 7% level. And since we recently saw a 14% gain on the past 10 year basis, I would tend to say yes, definitely expect us to come back to a more normal compound annual growth rate, but not necessarily feel like we're going to lose out on an entire decade.

BRAD SMITH: Sam, when you think about some of the margins particularly-- and what you've actually sent over to us is the expectation for the Q3 ESP-- EPS, excuse me-- growth, that was estimated at 10.5%, as of the midpoint of this year. But now you're looking at 3.1%. Where are some of the expectations?

Where do you expect that to be downgraded, perhaps, in the near term from some companies? We've already heard this from FedEx. They cited macroeconomic, kind of global landscape right now. So what would be the next shoe to drop?

SAM STOVALL: Well, I think certainly, expectations are maybe communication services. They were expected to be down 2%, now down 14% expected. I also think that health care probably could see some trimming. Expectations were for a 2% rise, now a 6% decline. And also, just see financials probably with a bit of a expanded reduction, mainly because we've been seeing the inverted yield curve, which tends to hurt their interest income.

So I would tend to say we're talking about profit margins. Profit margins were expected to be off less than 1% as of June 30 for the third quarter. Now they're expected to be down 6.5%. So profit margins are going to be challenged, I think, in this reported quarter.

BRIAN SOZZI: Sam is now a good time to, or a really good time, to be buying dividend stocks on pullbacks?

SAM STOVALL: Well, I think so. I mean, certainly, I think investors who are income-oriented should be thinking like landlords, not like traders. Focus on what the yield is that you need. But also make sure that your tenant, if you will, has the track record of paying the rent and does not squawk when you raise the rent. So looking at things like the S&P Dividend Aristocrats, which have had a 25-year run at a minimum of increasing dividends on an annual basis, would be a good place to start.

BRAD SMITH: CFRA's Chief Investment Strategist, Sam Stovall. Always a pleasure to speak with you, Sam. Thanks for joining us this morning.

SAM STOVALL: My pleasure, thanks.