Updated chart of S&P 500

By David Morrison  |  17/12/2018 15:55

Last week’s vicious sell-off in the major US stock indices has extended into Monday’s session. This has seen the S&P 500 break below the triple-bottom that formed between October and December

Global stock indices continue to correct to the downside as investors lighten up their exposure to equities. Soon after the US open the S&P 500 hit its lowest level since early April and today’s move followed on from Friday’s hefty sell-off. There are many excuses being touted around for the current weakness including the ongoing US/China trade dispute, a flattening yield curve, political and social unrest across Europe, Brexit, a fall in the oil price, slowing global growth, a turndown in inflation and worries that US corporate earnings have peaked as the positive effects of Trump’s fiscal stimuli diminish. Many of these factors are interrelated.  But perhaps the most likely reason for the current sell-off is that we’re now experiencing the effects of tighter monetary policy from the developed-world’s central banks.

Hangover from the financial crisis

The financial crisis of 2008/9 led to an extraordinary experiment in monetary policy which saw world central banks hose liquidity into the financial system. While all this fresh liquidity did little to shift the needle on mainstream inflation measures, it boosted assets such as housing, equities, bonds, antiques and art works. It also saw corporations borrow enormous sums, not to invest in staff, plant and machinery, but to buy back their own shares. Now the process is being reversed. Led by the US Federal Reserve, we’re seeing rate hikes, the end of quantitative easing and even quantitative tightening. Consequently, investors are taking measures to realise gains, or limit losses, as the cost of borrowing rises.

Christmas rally?

It’s looking less and less likely that we’re going to experience a Christmas rally. But the recent pick-up in stock market volatility means that traders should be prepared for further wild swings. This is especially the case as Wednesday’s US Federal Reserve monetary policy meeting approaches, and as we inch closer to next week’s holiday break. Unfortunately, the Fed is stuck between a rock and a hard place. Just a few months ago Fed members were still pointing to strong US growth numbers, low unemployment and headline CPI inflation above their 2% target as reasons to raise rates. Now the betting is that the central bank will pivot away from this hawkishness on Wednesday with a ‘dovish rate hike’ (it will raise rates by 25 basis points but roll back on its forecast of a further three hikes in 2019) or maybe no hike at all. The trouble is that this may frighten off investors even more than the prospect of rate rises next year. After all, it will signal hard economic times ahead with very little room for the Fed to manoeuvre with rates as low as they currently are.

S&P breaks support

As we can see from the chart, the S&P 500 has broken below the triple bottom that formed between October and December. In fact, having taken out 2,630 to the downside (which now becomes resistance) the index sliced below 2,600 to trade at its lowest level since early April. At the same time, we can see that the 100-day Exponential Moving Average (EMA) is getting close to breaking below the 200-day EMA (the 50-day crossed below it some weeks ago). This suggests that a change in trend is developing. Certainly, traders have become very wary of dip-buying, a strategy that has worked so well for so long and now appear happier to sell any rallies. But care must be taken in these markets and there’s always the danger of being sucked in to a bear trap. Nevertheless, sentiment has soured rather dramatically over the fourth quarter.




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