S&P 500 closes in on record high

By David Morrison  |  08/08/2018 15:11

Investors and traders continue to push US equities higher with the key S&P 500 just 0.5% below its all-time high from January this year

Less than a month ago the S&P 500 broke above a line of resistance just under 2,800. As shown on the chart below this was an area marked by the 76.4% Fibonacci Retracement of the Jan-Feb sell-off earlier this year. Since then this area has acted as support which was tested on several occasions last month. However, the line held and there’s been a strong upside move over the last six days which has taken the S&P to within striking distance of its all-time intra-day high just below 2,880 at the end of January. Of course, we can all see what happened straight after that. But this time the bulls will be hoping not only to take out the high but build upon it. That could be possible if short-sellers decide to throw in the towel, wondering just what it will take to knock the US equity market back to more ‘reasonable’ levels. On the flip side, a retest of the highs could see fresh shorts appear, particularly if the index ends up experiencing a false breakout to the upside.




 
There’s no doubt that traders have scaled a dauntingly-high ‘wall-of-worry’ since March. Trump’s original threat of tariffs on Chinese exports have come to fruition and the tit-for-tat response is ongoing. Earlier today China announced tariffs of 25% on $16 billion of US imports, effective 23^rd August. This is a direct response to the imposition of US tariffs on Chinese goods, set to come in on the same date.   

However, any market damage (to US equities anyway) has been more than offset by another two quarters of stellar US corporate earnings together with encouraging economic data. The earnings season is ending with just under 80% of S&P 500 constituents beating expectations on both earnings and sales. Data-wise, the initial print for second quarter US GDP came in at an impressive +4.1% annualised, the strongest rate of growth since the third quarter of 2014, and well above the +2.2% from the first quarter. Meanwhile, unemployment continues to hover around a 17-year low, headline CPI is comfortably above the Fed’s 2% inflation target (even if Core CPI is a tad under) and Industrial Production is trending higher. All this contributes to the Fed’s assessment that the US economy is “strong” and bolsters the view that the US central bank will continue to tighten monetary policy by raising rates and reducing the size of its balance sheet.

But some investors are expressing caution. They point out that second quarter GDP may have got a temporary and misleading boost as corporations brought forward purchases to beat tariffs. And while Manufacturing and Non-Manufacturing PMIs show expansion, both forward-looking indices are down since April with Non-Manufacturing particularly badly hit. There’s also a feeling that we may have seen the best from corporate earnings growth, particularly as strength in the second half of 2017 won’t flatter the year-on-comparisons for the next six months.

US stocks may be overvalued by many measures and we may have hit peak earnings growth, but these look like issues for another day. On top of this we’ll have to wait another three months to see if US corporations really were ‘channel stuffing’ to get ahead of tariffs. Meanwhile, US GDP is outstripping growth in other developed countries by miles. The bull argument is that tax cuts and share buy-backs are helping to keep the US is the cleanest shirt in the laundry basket. The story goes that if you’re forced to pick, then US equities is where your money should go.

But markets don’t operate in isolation and there are reasons to be cautious. The fact is that China’s Shanghai Composite remains in bear market territory, down over 20% from its January high. This has persuaded some to conclude that Trump’s tariffs are working: China is feeling the pain while US corporations reap the ‘benefit’. But the US is unlikely to emerge unscathed if tariffs morph into an all-out trade war which drags in other countries. This is something that can’t be ruled out, but for now investors don’t care. The attitude appears to be that there will be plenty of time to get out of Dodge, although that assumes that a bell will ring to let everyone know the good times are over.

Meanwhile, the Fed is tightening monetary policy, as is the Bank of England. There are concerns that they’re doing this at the wrong time in the cycle which would be the case if GDP and corporate earnings growth start to roll over. Indeed, some analysts are pointing to the flattening of the US Treasury yield curve which appears to be indicating tougher times ahead. But for now, both the European Central Bank and Bank of Japan are continuing with their zero/negative interest rate policies and asset purchases. This means there’s still monetary stimulus coming into markets even as the Fed tightens.

Overall it looks as if it’s sensible to be cautious, particularly as we approach the end of summer and the third quarter.
 
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