S&P 500 Recap Week ending April 13th 2018:
As you can see from the chart below the S&P 500 finished the week higher. Earnings season kicked off in earnest towards the end of the week with some of the big financials reporting on Friday. They all came in ahead of expectations and the markets rallied on the back of it on Friday. However, the rally was somewhat short lived and the market gave back the gains towards the end of trading on Friday.
From a technical perspective, the S&P 500 broke through a key short term resistance point at 2650 (black dotted line). However, volume was lighter than normal which doesn’t suggest a lot of conviction behind this move (yet).
The next short term resistance is at the 2700 level with both the 50 and 100 day moving average (purple and blue line above) acting as resistance. We also had a bearish crossover of the 50 day and 100 day moving average (50 day and 100 day moving average above). It will be interesting to see how long it takes for the market to breakthrough these resistance points.
The money flow index (chart above) suggests that money is flowing back into the index in recent days. For the short term traders out there, there are lots of mixed signals going on out there – some bullish, some bearish.
VIX (Fear Index):
The investor fear index (VIX) tracked lower during the week. This suggests that fears of a trade war with China and/or other geopolitical fears are starting to wain. However, you musn’t forget that coalition forces attacked Syria over the weekend and there has been a lot of rhetoric between Russia, Iran, Syria and the coalition forces. It will be interesting to see how this plays into the fear index on monday.
Above you will see a chart of the US 10 year government bond. During the week the newsflow from the Federal Reserve (aka the FED) suggests a mixed view, some in favor of more interest rate hikes and others suggest a more neutral stance. The yield curve flattened a little as a result which is a cause of concern but not an immediate risk to the stock market.
History shows that from the time the yield curve becomes inverted, it can be another 6-12 months before stock prices fall. However, we have never had such an extended period of low interest rates either so history may not be a great indicator in this occasion.
For the past 3 years the S&P 500 has traded at elevated PE multiples primarily due to low interest rates, excellent corporate profits and a slowly recovering economy. These earnings multiples got even more elevated after Trump got elected. His promises of deregulation and tax cuts fuelled the stock market and corporate profits are set to be a big benefactor. Earnings are expected to rise by 20% this year and 10% next year for the S&P 500 companies!
I believe that this news is priced in and the stock market will now trade at realistic (not elevated) multiples of earnings. There are lots of geopolitical risks such as China trade Wars, Syria and impending US elections with the Democrats potentially taking control of both houses of congress.
Factoring all of that in we believe that the target range for the S&P 500 for the next 12 months will be 2600 to 3000. Currently we trade at 2653. That indicates a range of -2% to + 13% from current levels.
As I have said for the past few months I would be a buyer below the 2500 level. I’d see 20% upside from those levels. It is at these levels that I see the risk to reward ratio being favourable.
You can use an ETF such as the SPY to participate. The SPY is an ETF that tracks the S&P 500 index and it trades just like a stock. I like this ETF because you get instant diversification benefits from investing in 1 ETF. It trades at roughly 1/10th of the value of the S&P 500. At the moment the SPY is trading at $265.11. I would be a buyer of SPY at $250.
Implied volatility has pulled back in the last week and option premiums have come back in as a result. If we get a pullback in the market this week, I would then revert to the short put strategy or the bull put spread as discussed last week (Apr 7th). However if markets continue higher it might be best to sit on the sidelines until it gets to the upper end of our target range.
With earnings season kicking off, there will be opportunities trading the volatility in individual stocks. Personally, I prefer trading options on the Index but if you must trade stocks make sure you have done your homework on the stock and understand the fundamentals. Also keep the position sizing small.
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