S&P 500 Update: Week ending May 11th 2018 1. Market Recap: The S&P 500 closed higher by 2.2% for week and broke out of some key resistance areas and a short term downtrend. There are 4 topics now setting the tone for this market: Earnings - Excellent company earnings have been very positive for the stock market. What is interesting about earnings is that analysts believe that almost 40% of the increase in profits is due to tax cuts and share buybacks. Earnings this year are forecasted to increase by 20%. Even though growth is forecasted to be lower next year at 10%, it is still very healthy for the stock market. Inflation Risk & Bond Yields - Rising Bond Yields are a cause of concern and the yield curve is flattening. But the 10 year bond pulled back a little this week on economic data that suggested inflation is still in check in the US. Trade Wars - Trade Wars are a real risk for the stock market - this week was very quiet on this front. Recession Risk - the probability of a US recession in 2020 is increasing. This should keep this market in check. If this market rallies hard from here, you can expect major corrections along the way - as bulls and bears wrestle with record earnings versus recessionary risks further down the line. If the risks of a US recession in 2020 continue, you can expect the market to price that in from early to mid 2019. This would indicate that there is less than one year left in this bull market. Let s have a look at the charts.
2. Technical Review: Chart of SPY (ETF that tracks the S&P 500) Main resistance remains at 2,800 (2.6% higher) and support at around 2,580 (5.3% lower). Friday s trading action confirmed a breakout above short term resistance which was set almost a month ago. Also the chart below confirms a breakout from the trend of lower highs and a breakout above all major moving averages. It looks like the bulls are taking back control (for now!). Above you see the 200 day moving average (green line) providing support at 2621. Then we have the 10 day (redline), 20 day (yellow line) crossing at the 2677 level. This is a short term bullish signal. If the 10 and 20 cross above the 50 day moving average
(black line) it will be a further bullish signal. The recent downward trend is now broken from a technical perspective. S&P 500 Bollinger Bands The shaded area with the two dark yellow lines are called bollinger bands. The bollinger bands in the chart above represent 2 standard deviations away from the 20 day moving average. When the outer bands are reached it can indicate buy and sell signals. Bollinger Bands can be good indicators to use in conjunction with others for sideways trending markets. The narrowing nature of the shaded area tells us that stocks are pretty much moving sideways and that volatility is contracting. The lower Bollinger support line at 2616 was not tested this week and now they are testing the upper end of the band at 2727. This maybe signalling a shorter term reversal on the way back to the moving average at 2673. Note: Use other indicators such as stochastics and money flow to confirm this. Please note that Bollinger Bands don t work well in bull or bear markets. They often giving you false signals. These should be used in conjunction with other indicators such as Money Flow, MACD, and Stochastics.
Above, you can see two momentum indicators: 1. Money Flow Index on top 2. Stochastics on the bottom. These momentum indicators work well in sideways trending markets. The idea is quite simple: When either indicator is below 20 the market is oversold - but not a buy yet. The buy signal comes when the indicator crosses back above the 20. When either indicator is above 80 the market is overbought - but not a sell yet. The sell signal comes when the indicator crosses down below the 80. Note: This holds true in sideways markets only! These do not work in extended bullish or bearish trends. Stochastics: Currently showing that we are overbought and maybe due a reversal shortly. This is occurs when the lines cross below the 80 line. Money Flow: didn t quite get into the oversold area either but has started to rise nicely over the past few days. There is no particular read on Money Flow as it hasn t reached an oversold or overbought condition in some time.
We see from the chart above that the S&P 500 has broken above the series of lower highs. Technical Summary: We have broken out of the series of lower highs - that s a bullish signal or at the very least a sign that this market will continue to move sideways between 2600 and 2800. Short term moving averages have given bullish signals and are no longer acting as resistance. Bollinger Bands are suggesting that we are at the upper end and that a reversion to the mean is possible. Stochastics are showing an oversold condition. This suggests a short term pullback is imminent. Last week I asked you all to exercise patience as the indicators were showing an inflection point. But now that the key resistance areas have been broken it is surely time to buy and hop on the bull train and ride this up to next resistance at 2800 (2.6% higher), isn t it? I m no mystic meg, I wish I could tell you exactly when stocks will rise and fall, but I can t. This market may rally straight to 2800 from here like a train but experience tells me to wait for a retest of old resistance(which is now support) and then buy on the bounce from there.
3. VIX (Fear Index): The investor fear index (VIX) tracked slightly lower during the week. Nothing new to report here this week. 4. Bond Yields: Above you will see a chart of the US 10 year government bond. Yields dropped below 3% again. I can t help feeling this is temporary and we will continue to go higher from here. Please read previous reports as to why Bond Yields are important to the stock market. You can get them in the April 2018 Market Updates and Webinars section of the website
5. Market Outlook: We are in a sideways market between 2600 and 2800. Short term resistance has been broken which suggests we are heading back towards 2800. Investors appear to be struggling with 4 forces: 1. Earnings - Excellent company earnings have been very positive for the stock market. This should drive stocks higher. 2. Bond Yields - Rising Bond Yields are a cause of concern to investors as the Yield Curve continues to flatten. This creates some uncertainty. 3. Trade Wars - Trade Wars are a real risk for the stock market - this could drive the market much lower. Any negative news here will likely cause a selloff. 4. Recessionary Risk - 2020 is now being talked about a lot as a mild recession in the US. Stocks normally price this in about 6-9 months in advance. If this holds true, then expect a selloff to start early to mid 2019. In the short term, if trade war fears subside we could go as high as 3000 on the S&P 500. But because of the new risks in the market I wouldn t be a buyer of it until the S&P 500 dropped to the 2500 level. In my opinion, this market should be traded as opposed to being invested into. Buy Low, Sell High between support and resistance is the name of the game for now. 6. Option Strategy: Implied Volatility has reduced again forcing us to consider debit type trades as opposed to credit type trades. If you think this market is going to rise from here you should look at: Long Calls Bull Call Spreads If you think this market is going to fall from here you should look at: Long Puts Bear Put Spreads As ever please contact us if you have any questions. Happy Investing Stephen