S&P 500 Chart (May 3rd 2018)

The S&P 500 is getting wedged!

S&P 500

The chart above is a 3 month chart of the SPY etf. The blue line represents the 200 day moving average and the two black lines are support and resistance trend lines.

What we have above is a classic ‘wedge pattern’ developing. This is when we have ‘solid’ support at $257.50 but the trend of lower highs converge into the support area. The index struggles to break above the lower highs trend line but gets ‘wedged’ back towards support.

This gives you a picture of the current uncertainty surrounding investors …. the market is not sure what direction it wants to go. The volume action in the last two weeks has also been below average which suggests no conviction in one way or the other.

With all wedge patterns, they eventually breakdown below support or break up and create higher highs. The question is which way will it go?

Unfortunately we are going to have to wait and see. The key here is absolute patience and not to jump in and make rash decisions. Let the new trend emerge and then invest accordingly.

Respected market analysts are divided on their opinion of this market. Some believe that we need to drop another 10%-15% before we can move higher, others think we are going 20% higher from here.

Let’s review some of the fundamental issues that could be driving their thoughts:

  1. US Economic Expansion – the US economy is doing well and at near full employment. This is a positive for the stock market in the short term but a big warning sign for the medium term.
  2. US Interest Rates are going higher – The Federal Reserve did not raise rates at yesterdays meeting but they did point to higher inflation risk going forward. Current yields are not too bad for the stock market right now but when interest rates get higher, safer government bonds will become more attractive than stocks. This will be a negative for the stock market when yields get to an attractive level.
  3. Yield Curve is Flattening – US Recession Risk for 2020 is now being priced into financial investment models. The market is no longer going to trade at elevated multiples of earnings. The good news is that ‘historically’ the market still has another 12 months of gains after the Yield Curve becomes inverted (not there yet!).
  4. US corporate earnings are blow out – Company earnings this quarter are beating expectations easily and forward guidance is being increased. This is usually extremely positive for stock markets. But investors are wondering what the underlying results are when the Trump Tax cuts are stripped out.
  5. Trump Tax Cuts – Many are now arguing that the Trump Tax cuts will accelerate inflation and become counter productive as costs rise. The ‘sugar high’ will evaporate. This is good in the short term for stocks but the jury is still out on medium term implications as the US debt continues to spiral out of control.
  6. Trump Trade Wars – In my opinion, this is the single biggest risk that could cause the stock market to sell off. i also think it is the most underestimated because of the the ego’s involved. Most commentators figure this is just a negotiating tactic for the US especially with China. Trump has extended exemptions on steel and aluminium tariffs with the EU for another month. This is positive as I don’t think the market will react kindly to a trade war between the EU and the US. Trade conflicts halt investment as companies try to figure out what is going to happen.

In summary, the chart above appears to be reflecting the conflicting fundamental issues above. Record earnings and tax cuts should suggest higher stock prices but inflationary risks, higher interest rates and a flattening yield curve suggest the bull market is at the latter stages (but not over yet). China & EU trade conflicts with the US could be what is holding this market back. Positive news on this front could kick start the rally again and drive the S&P 500 to 3000 (14% higher). More negative news could bring us closer to 2500 (5% lower).

Be patient and use good risk management strategies!

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