S&P 500 holding above 2,800

By David Morrison  |  24/07/2018 14:53

The S&P 500 is trading at its highest level since the sharp sell-off earlier this year as strong US earnings allay tariff concerns

Less than two weeks ago the S&P 500 managed to poke its head above key resistance around the 2,795/2,800 level. At the time it looked as if this could prove to be a false breakout. Despite the buying interest, investors remained nervous about the escalation in the US/China tariff tit-for-tat. However, such concerns appear to have been put to one side for now. In fact, some analysts are claiming that the equity market has already priced in global trade issues. This is despite President Trump’s threat last week to slap tariffs on all Chinese exports to the US. That would affect around $500 billion-worth of goods against the $34 billion currently affected.

Tariffs working – for US

It’s possible that investors really don’t believe that the Trump administration will follow up this rhetoric with action. If so, then they’re really taking a gamble. After all, Trump will look at his actions so far in the context of a strong US equity market while, despite its ongoing recovery (boosted by yesterday’s announcement of further fiscal and monetary stimulus), China’s Shanghai Composite is only just out of bear market territory. The US dollar is also holding up well while the official yuan rate is at its lowest level against the dollar in over a year. Overall, this suggests that tariffs are working out well for the US. With mid-term elections coming up in November, Trump has every incentive to go further, hoping that China will blink first and back away from retaliatory measures. In addition, it’s possible Trump will once again brand China a currency manipulator, blaming Beijing for the yuan’s recent weakness.

Earnings boost

For now, US equities are getting a boost from the second quarter earnings season which is well underway. Of the 21.4% of S&P 500 companies that have reported so far, more than 80% have beaten analysts’ estimates. Last night Alphabet (Google’s parent company) released a particularly strong set of numbers. The news lifted the stock price by 4.5% in early trade, helping to take the NASDAQ to a fresh all-time high.

GDP surprise in store?

On top of this investors are looking ahead to the second quarter US GDP number which is out this Friday. The consensus expectation is for growth to come in at +4.1% annualised, well above the last quarter’s +2.0% reading. However, there’s been increased speculation that it could come in considerably higher than this with Barclays forecasting a number above 5.0%.
 


Looking at the daily chart of the S&P we can see how the area just below 2,800 was tested a couple of times following the stock market plunge between the end of January and early February this year. Now it has been broken and the next upside target is the all-time high of 2,877 hit just before the sell-off. Investors continue to climb the ‘wall of worry’ and no doubt there will be plenty out there ready to take out the high. Many argue that not only is the S&P set up technically for a continuation of the rally, but that US equities offer better opportunities than those of other developed countries or emerging markets.

Caution still justified

Meanwhile, the central banks of China, Japan and the Euro zone are still employing loose monetary policy, although the ECB has signalled that its bond buying programme will end this December. But this monetary stimulus is a response to economic growth which is either slowing or flatlining depending on the region. Some of that cheap money will inevitably flow back into US equities. However, there’s every indication that the Federal Reserve will ignore President Trump’s criticism over rate hikes and continue to tighten monetary policy. And while the past few days have seen the yield curve widen again, this could prove to be a temporary respite from the downward trend of curve flattening.

The current bull market is looking long in the tooth. That’s not to say equity markets can’t rally substantially from here. But the potential downside from a policy misstep, disappointing data or simply from buyers looking to book profits, is substantial.
 
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