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S&P 500 backs away from record highs

By David Morrison  |  16/08/2018 15:04
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Just over a week ago the S&P 500 looked like making a fresh record high. Does the pull-back since then mean the top is in?

European equities and US stock index futures rose sharply on Thursday morning in moves which went a long way to offset the previous day’s losses. The rally followed news that China would be sending a delegation to the US to resume trade talks, or rather, hold talks about trade talks. Vice Commerce Minister Wang Shouwen will meet with his US counterpart David Malpass later this month. An earlier attempt to diffuse the two countries trade disagreements broke down a couple of months ago.

Earnings lift equities

Last week the S&P 500 was little more that 0.5% away from the all-time high reached at the end of January. A combination of yet another strong quarterly earnings season, with accompanying announcements of dividends and share buybacks, together with an impressive second quarter GDP number helped to offset concerns that a full-blown trade war was in the offing. Consequently, investors and traders rushed to add to their holdings of US equities. The buying escalated after the S&P broke above resistance around 2,800 and the momentum was undoubtedly to the upside.

Emerging market risk

But we’ve seen a pull-back since the 8th August and Wednesday’s sharp sell-off brought the S&P to within a few points of 2,800 once again. Investors showed signs of panic in early trade as fears grew that the ongoing rout in emerging markets would spill over into Europe and thence the US. Earlier today it was confirmed that an index covering European banks had fallen into bear market territory - down more than 20% from its recent highs. Last week the ECB warned that Southern European banks had a large exposure to Turkish debt. The Bank for International Settlements (considered the central banks’ central bank) calculates that Spanish banks have an exposure of over $80 billion while French and Italian banks are owed $38 billion and $17 billion respectively. This debt has come into sharp relief following the precipitous decline in the Turkish lira. While the currency has recovered this week, concerns remain that the lira may resume its decline unless President Erdogan backs down on his promise that interest rates won’t rise. The fact that we saw such a sharp sell-off across global stock indices on Wednesday, even as the lira rallied, is indicative of just how jittery investors are.

Trade talk boost

News of fresh trade talks between the US and China came at just the right time for equity bulls. It has helped to turn around a market which was in free-fall at one point on Wednesday, although a late spurt of short-covering helped to lift all the major US indices off their intra-day lows. The question now is whether the possibility of a rapprochement between the two countries will be enough to keep the rally going. It may be, particularly if we now see a sustained turnaround in the emerging market sell-off. But that would require a substantial pull-back in the US dollar, something which may prove elusive given the US Federal Reserve’s determination to tighten monetary policy further.

Dollar strength

Dollar strength could yet weigh on the major US indices. In much the same way that a large percentage of FTSE 100 constituents receive a significant proportion of revenues from overseas markets, the same is true of the S&P. Consequently, as sterling strength typically weighs on the FTSE 100, a stronger dollar weighs on the S&P 500. There is pressure on international sales as the stronger dollar makes US goods and services more expensive in other currencies. On top of this the second quarter earnings season is ending. This means that the S&P will soon lose the support it got from positive news from the corporate sector.

Volatility rises

Today we’re seeing the buyers rush back in, putting to one side any concerns over trade wars, emerging markets, dollar strength and Fed tightening. But volatility is picking up a touch. So yet again it pays to be cautious.
 

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