Wall Street is continuously approaching near record highs as seen by the stock market’s consistent rise last week. However, this raises some doubts among investors. Can this trend be trusted? Or is Wall Street expecting an unsteady market in the next few weeks?
Following a missile attack on Saudi Arabia’s key oil producers last week, the S&P 500 fell back only 0.5% just within 1% of a record peak. Aside from the attack which caused several disruptions in production and a price hike in oil, the S&P 500 drop can be attributed to technical issues in the overnight bank-funding market. Moreover, the Federal Reserve meeting did not shed full light on the future policy path.
Upon observation, the markets that refuse easy opportunities for selling off receive more support by more powerful investors who plan to improve foundational developments.
Observers claim that this is what’s happening now, citing the wide span of the stock market’s rebound from the August declines. The running tally of advancing against declining NYSE stocks, also known as the cumulative breadth indicator, peaked at a record high last week. As history states, this event is usually followed by a new index high.
The 20-month long sideways pattern of the S&P 500 can also greatly influence any conclusive break above July’s peaks, which bears resemblance to their 2016 rise that followed an extensive sideways phase.
It is also valuable to note that in the summer of last year, cumulative breadth started declining before the S&P 500 began to rise. Last Friday marked a year since reaching the 2018 top which was followed by a 20% drop into the end of the year.
Last Year’s Market
If you compare today’s forward valuation with last year’s stocks, you will find them similar. However, September 2018 market was more costly versus a Treasury yield of 3% and corporate bonds of 4% during that time.
Additionally, market expectations last year were more optimistic compared to 2019. The Cboe Volatility Index (VIX), a measure of the stock market’s volatility, was under 12. This measure showed some complacency, and the Federal Reserve was expected to be in tightening mode for this year.
Since then, the S&P 500 has risen to 2% with 10-year Treasurys at 1.8% and corporate debt yields about 3%. The Fed is maintaining a loosening bias despite two rate cuts, which is an indication of a better valuation for equities. That is if earnings forecasts do not collapse in the next few months.
This year, the VIX is already above 14. This number is a neutral reading that can be attributed to less strain from August drops. However, it still does not indicate optimism for the stock market’s volatility in the coming months.
Economic readings are looking more stable recently, as well, showing more faith in the optimistic idea that the global slump has given equity investors a more dovish Federal Reserve and less interest-rate obstacles without a risky economic decline.
Improvement has shown for “hard” economic gauges of activity versus the “soft” indicators for economic-sentiment, which explains why the stocks are where they are right now. It is also safe to say that the broad tape deserves potential logging of a new record high after Microsoft and J.P. Morgan Chase shares reach record highs last week.
What to Expect Ahead
Investors expect the calendar to be rocky up ahead, particularly the next three weeks from today.
The S&P 500 has stalled just half a percentage away from their old records, which is incidentally at the 20% threshold for year-to-date-gain. Meanwhile, Treasury yields have increased from last month’s lows but stay below 2% for all maturities. This suggests that there is no market verdict yet for growth speed-up.
Small-cap and bank stocks, which are risk-on sectors, have shown a significant increase from their slumps. However, their rebound can be attributed to mechanical mean-reversion instead of a shift in the market toward cyclical leadership.
Additionally, the U.S. and China trade war headlines still cannot be shaken off by the tape.
Although, investors were accepting of Fed Chair Jerome Powell’s message saying that the Federal Reserve’s next move is not certain and it will depend on the economy’s performance.
“They [Fed officials] are not kidding when they say they do not know whether they will be cutting on October 30 or December 11,” Barry Knapp, managing partner at Ironsides Macroeconomics, weighs in. “We think they are either going to not cut or be forced to cut at both meetings.”
Referring to 2018’s instability amidst ideal seasonal rhythms, Knapp also adds: “when the late year favorable seasonality fails, it fails spectacularly.”
Following the same logic, if the stock market beats the expectation for weakness and volatility this September and follows a decline in the following season, has the bear market missed its golden opportunity?