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S&P breaks winning streak

By David Morrison  |  07/02/2019 13:24

US and European stock indices are losing the upside momentum that has boosted them so far this year. Positive sentiment appears to be waning
All the major US stock indices ended Wednesday’s session a touch lower in a move which saw the S&P 500 break a 5-day winning streak. Early indications suggest that US equities will open significantly lower this afternoon as markets appear to be losing some of their upside momentum. But that shouldn’t be surprising given the speed and scope of the rally since Christmas. Investors became massively bearish in the fourth quarter of 2018 as they fretted about tighter US monetary policy, slowing global growth, recession fears and the US-Chinese trade dispute. This all contributed to a sell-off which saw the S&P lose over 20% between October and December last year.
Relative Strength Indicator
As can be seen from the chart below, according to the Relative Strength Index (RSI) the S&P was oversold in late December. But the RSI isn’t a predictive indicator. Just because it shows that a market is oversold doesn’t mean that market is about to rally. After all, the S&P was also notably oversold at the beginning and end of October and look what happened next. Currently, the RSI is below 70, the level that many analysts take as critical in indicating an overbought market. So, it’s not exactly flashing a danger signal, although the S&P is at its most overbought level since late September, prior to the bear market decline.
Shift in sentiment
Of course, sentiment has shifted quite dramatically since then. Thanks to the Fed’s dovish pivot, investors are no longer concerned about further rate hikes this year. Nor are they worried that the Fed is on ‘autopilot’ when it comes to its balance sheet reduction programme. There’s also a growing feeling that the US and China will hammer out a trade deal before the end of this month, so avoiding higher tariffs on Chinese exports and tit-for-tat retaliation. However, there’s no doubt that global growth is slowing, most notably across Asian Pacific countries and the Euro zone. Just this morning the European Commission downgraded its forecasts for inflation and GDP growth across the Euro zone for 2019. Meanwhile, German Industrial Production came in well below expectations, adding to fears that the EU’s largest economy will fall into a technical recession when it releases its fourth quarter GDP reading next Thursday.
Earnings season

On top of this, the fourth quarter earnings season has been mixed. At the half-way stage, the blended earnings growth rate for the S&P 500 is around 12.5% for the fourth quarter. While this is perfectly respectable, it is well below the 20%-plus rates seen earlier in 2018. There’s also been a sharp pick-up in negative forward guidance suggesting that corporations may struggle to beat current analyst estimates for 2019 without some sharp downward revisions. All this suggests that equities may struggle to make further significant upside gains over the next few months. Technically, traders are keeping a close eye on the 200-day moving average. Now, this is somewhat subjective. While the S&P is still below its Simple Moving Average at 2,740, it has broken back above the 200-day Exponential Moving Average (around 2,700). Despite these conflicting signals, it’s probably worth being cautious for now.
S&P chart
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