Inflation and the S&P 500

By David Morrison  |  12/02/2018 16:30

This article looks at price action on the S&P 500 and homes in on Wednesday’s CPI release

Why the S&P 500?

This article will focus on the S&P 500 for several reasons. Firstly, the index covers the US which is the single biggest contributor to global GDP and issuer of the world’s reserve currency. Secondly, it is weighted by market capitalisation rather than being price-weighted like the Dow Jones Industrial Average. This means that there’s less chance of a single company having an outsized influence on the price. Thirdly, the S&P 500 is a bigger and more diversified index than the NASDAQ 100 and finally because of the importance of the VIX which is a measure of stock market volatility based on S&P options.

S&P closes above support

Wall Street’s recovery on Friday was certainly welcome news for long-side investors and holders of equities in general. But the rally saw it push back through resistance around 2,600 and this has rather complicated the technical picture. This is making it even more difficult than usual to try and forecast where markets could go next.  If it had closed below here then it would have been fair to say that the next move would have been to the downside. But Friday’s bounce will have given potential dip buyers the confidence to re-enter the market with stops around 2,600. Yet even after the rally the S&P ended last week at a two-month low having previously traded down to levels last seen in October 2016. More significantly, this was the index’s biggest high-to-low downside move since the beginning of 2016, when China devalued its currency for a second time in less than six months.


Still in danger

The S&P 500’s upside momentum carried through to today’s pre-market trade. Just prior the official open the S&P 500 was closing in on the 100-day simple moving average (SMA) which comes in around 2,655. But US equities aren’t out of danger yet. As the attached chart shows, the S&P is stuck within a band with resistance around 2,700 and support (previously resistance) around 2,600. A break to the upside (which would first have to clear the 100-day SMA) would indicate that the correction is over. A break below 2,600 would suggest that there’s a bigger shakeout coming with a retest of the 200-day SMA around 2,560 being the first major downside target.

CPI in focus

Now it’s probable that we’ll get a resolution to this at some stage this week. However, it may not be until after we see the January update for US CPI on Wednesday. After all, it was the fear of a pick-up in inflation that led to the spike in US Treasury yields which in turn helped trigger Wall Street’s sell-off. Just over a week ago Average Hourly Earnings came in way above expectations, sparking concerns that higher wage growth would force the Federal Reserve to raise rates by 100 basis points this year, rather than the 75 basis points previously anticipated. Headline CPI came in at +2.2% in November – slightly above the Fed’s 2% target (as measured by Core PCE) – but slipped back to 2.1% in December. Investors are hoping for further evidence that inflation has topped out for now. In the current environment we can expect US Treasury yields to soar if January’s number were to come in at 2.1% or higher. This would be a problem as the key 10-year Treasury note yield is dangerously close to testing 3.0% - a four-year high, increasing fears that the 35-year bond bull market is finally over. This would signal higher borrowing costs to come which would not be good for global equities. 


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