Is the rally in S&P 500 set to resume or could the Coronavirus fears restrict that?

Marius Paun | London, UK | Senior dealer | Wednesday, 05th February 2020

As the World Health Organization has declared coronavirus a global health emergency last Thursday, we felt was worth a look at the effect the outbreak has had on the global equity markets (using S&P 500 as an indicator).

To put things into perspective we need to step back and consider the incredible rally in equities during 2019. Very few analysts thought S&P 500 would gain more than 28% last year, given the disruptive trade dispute with China and a slowdown in the global economic growth. We should remember that 2019 started with bears rather in control. The sell-off started in late 2018 and pushed S&P 500 firmly down, placing it within a whisker from the bear market territory (20% decline from its peak).

That convinced the US Federal Reserve that its monetary policy was out of sync with the markets (they raised interest rates 4 times in 2018). So they changed course and this time lowered rates 3 times in 2019. The Fed added extra clarity by saying the rates are expected to remain unchanged for 2020. Consequently, hungry for yields, investors moved back into S&P 500, triggering a sharp rebound. Further support was offered when Trump administration reached a phase one trade deal with China.

On top of that is the tech stocks issue. There is no secret that they are now high in demand, closely followed by almost all fund managers. And two tech stocks, Apple and Microsoft, both with a market capitalization of more than $1 trillion, accounted for around 15% of the S&P 500 overall gains. Apple increased 85% and Microsoft rose 15%.

So the comeback was truly a happy combination of a booming US digital economy with a renewed easy monetary policy. The million-dollar question is will that momentum remain strong enough to trump the uncertainties brought by a possible spill-over effect of the coronavirus?

As it stands the Chinese authorities reported on Wednesday the death toll surged to 490 with confirmed cases now at 24,324. Despite that, the WHO seemed rather confident the epidemic could be contained as measures taken by authorities to stop the spreading were deemed much swifter than in the past.

Former Federal Reserve Chair Janet Yellen expressed cautious optimism regarding coronavirus. On one hand, she acknowledged the threat to the world economy due to the spill-over effect given that China has now become a global trading player. As such a disruption in the global supply chain should undoubtedly be taken into consideration. Reuters reported that a Chinese economist working for the government expressed concerns the economic growth in the first quarter of 2020 could drop to 5%.

However, as Yellen pointed out, past epidemics such as the SARS outbreak in 2003, had only a short-term negative impact. There may be the temptation to say ‘this time is different’ but the statistics tell us that similar past epidemics had only limited effects on long-term. To help alleviate the fears and reassure the world markets of its support, the People’s Bank of China said on Monday 3rd of February that it will be injecting 1.2 trillion yuan ($240 billion) into the financial system. Even the US President Donal Trump said during State of the Union address that his country is ‘working closely’ with Beijing government to contain the coronavirus.

Despite those reassurances and common-sense approach from a wide array of finance and media analysts, markets turned rather pessimistic on Friday. S&P 500 pulled back 1.8%, its biggest one-day slump since October. Since then it recouped the losses and it’s now on course to retest the all-time high of 3337.5 reached on January 22nd.

The overall trend is up with a string of higher highs and higher lows clearly visible on the chart.

The short-term range is between 3213.88 and 3337.5. The market price is now above both the short and long-term moving averages and both indicators are pointing upwards.

Bullish scenario:

A sustained move above 3306.4 indicates the presence of buyers. The price has now crossed back above the short-term moving averages. Retesting the all-time high of 3337.5 is now a distinct possibility which would signal the near-term uptrend is intact.

Bearish scenario:

A breach below the 3213.88 the low of 31st of January will signal the sellers are making a comeback. The next downside target will be 3180.8. If that level fails as support the downtrend could extend to the 23.6 Fibonacci retracements at 3092.