Growing Momentum for S&P 500 Sellers

Marius Paun | London, UK | Senior dealer | Thursday, 29th October 2020

S&P 500 was slightly higher on Thursday afternoon, rising 0.7% after the previous day violent selloff to trade around 3300. The rebound came after the US Bureau of Economic Analysis showed the GDP in the third quarter grew by 33.1% on a year on year basis. The data beat the official consensus for a 30.9% growth rate (a record in itself) but less than some estimates i.e. the Federal Reserve Bank of Atlanta which predicted a growth rate of 37%.

Yesterday, the US stock markets posted a sharp decline with S&P 500 losing more than 3% after it becomes increasingly clear to investors that a stimulus deal, agreed before the election, is rather unlikely. How soon will probably depend on who gets into the White House? So election uncertainty took its toll on stocks. In addition, the election results could take some time to be confirmed, which might delay the stimulus even further.

Also weighing on sentiment were the growing fears of another lockdown. The US COVID cases are ticking up, speeding up the urgency that help is needed. That’s important, especially when polls indicate the pandemic is a top decider for voters electing the next US President, ahead of the economic issues. We have seen in the last few days that a full-on second lockdown is engulfing Europe, as authorities are desperately trying to stop the spread there. It’s only natural the US investors getting spooked, wondering when another shutdown will also happen across the Atlantic. Usually earnings season is good for stocks but so far this week it hardly seemed so.

The political game in Washington does not seem to have helped either, as Congressmen have been treating the new stimulus package as a tool to divide voters. The Federal Reserve warned it is badly needed to smooth out the recovery and lift the uncertainty amid a resurgence in COVID infections. The Fed’s Beige Book report released the previous week painted a more optimistic picture than September but the recovery looked uneven which threatens to become a permanent state of affairs unless federal relief is offered sooner rather than later. Nevertheless, the US economy is predicted to rebound at a ‘slight to modest pace through October’ after consumers continued to buy homes and increase spending.

Fundamentals do look rather worrying on the short term, but long term it could be a different story. One issue that perhaps deserves some extra attention regarding stocks in general and S&P 500 in particular, is that valuations are getting expensive amid prices near all-time highs even allowing for the recent pullback. During previous cycles, investors might have been a bit edgy looking at S&P 500 trading at north of 20 times forward earnings, particularly as 16 times was considered more like the norm for fair value. These days that number seems to have gone out of the window.

Possibly the best reason for this lies in the fact that interest rates have gone down close to zero. That has implications for the entire bonds spectrum which appear to now be considered way too expensive. It’s quite understandable that 10- year US Treasuries yielding less than 1% could push a potential investor into stocks as a viable alternative in his quest for a better return for his risk. Going forward, stocks buyers could get comfortable with higher valuations becoming the new norm as there is no end in sight to the world of low-interest rates (the Fed said it!).

Some of the technology stocks like Apple, Amazon, Google, Facebook, Microsoft have indeed seen valuations moving considerably higher but is it fair to compare them to the bubble of 1999? Some analysts have already pointed out the rally in 1999 had a lot more companies with no earnings at all. The Technology index is trading around 26-27 now, roughly half where it was in 1999. Their earnings seem solid with positive cash flow and growth. Last but not least, the tech stories like 5G adoption are considered a true tech revolution, a supercycle and that has not even started properly.

So yes, there is a lot of uncertainty on the short term regarding the US elections and COVID but history suggests those will pass. On the long term, amid a world of low-interest rates for the foreseeable future, the tech giants already dragging S&P 500 out of March lows could be hard to discard. They might initially appear to be expensive, but relative to bonds?

The chart shows an all-time high of 3588 reached on September 2nd followed by an attempt to retest that on October 12th with the high at 3549.8. A double top formation which could bring more trouble on the short term especially if the low of 3209 touched on September 24th does not hold. It would show that on the short to medium term we have lower highs and lower lows.

The moving averages are pointing lower with short-term one now below the longer-term one. The price is below both indicators. The immediate term outlook points south. Bears are now in control with the downtrend gathering speed. On the way down the next support is just above 3200 marks. A successful cross below that will bring into focus solid resistance turned support at 3130. On the way up bulls need a close above 3320 if the rebound is to have any chance followed by 3360. They tried this morning to test 3320 but failed so a bit of a dead cat bounce after recent selloffs. However, if they succeed in pushing higher, a more serious resistance can be seen around the 3400 handles.