Marius Paun | London, UK | Senior dealer | Wednesday, 04th December 2019
S&P 500 retraced 0.7% to 3,093 on Tuesday, led by losses in chipmakers like Nvidia, Micron and Advanced Micro Devices. At its intraday low, the S&P 500 was 1.7% down with the move extending losses seen on Monday session. The reason behind the drop was a statement made by the US President Donald Trump, who said that ‘it may be better to wait until after the next year election before making a trade deal with China’. That rattled the world markets especially when the US is due to impose fresh tariffs on Chinese goods starting on December 15, just 2 weeks away.
But that was just the icing on the cake because alarm bells had already sounded a few days before. First, France introduced a 3% digital services tax (for the revenue generated in France) which the US immediately dubbed unfair for its tech companies. In retaliation, the White House announced it could impose duties of up to 100% on over $2 billion imports of cheese, wine, champagne and other goods. Furthermore, upset that Argentina and Brazil have ‘presided over the massive devaluation of their currencies which is not good for American farmers’, Trump promised to restore tariffs on steel and aluminium imports. Both countries have received waivers after the US imposed tariffs of 25% on steel and 10% on aluminium last year.
Going into 2020 Wall Street top strategists expect US-China trade progress to remain the key issue helping (or not) S&P 500. There are indeed risks in the form of geopolitical turmoil and overstretched valuations which limit the potential upside but being also an election year should offer some support if history is anything to go by.
S&P 500 was the second-best performer among the major asset classes (according to CNBC FactSet) which rose more than 20% in 2019, even allowing for Tuesday’s selloff. And one driver often mentioned in the press was the ongoing low-interest rates. During the meeting of late October, the US Federal Reserve cut interest rates by 25 basis points to 1.75%. When he was put in charge, Chair Jerome Powell appeared to signal that he will change course from the dovish stance adopted by his predecessors, Janet Yellen and Ben Bernanke. As the economy still grew, albeit at a slower pace, he wanted the October cut to be the last one. He also acknowledged that bar a spike in inflation, interest rates won’t be hiked for the foreseeable future.
But what really matters in the grand scheme is that the Fed has restarted the printing press despite dismissing talks of that being called quantitative easing. But the effect is hardly different (still easing monetary policy) and there was no hint if that was to be stopped any time soon. So, for all the shouting at him on Twitter from Donald Trump, Jerome Powell could be more of the same. It’s true that he does not entertain the idea of negative interest rates (Trump seems to be in favour) but any sign of markets distress and he comes to the rescue.
However, at the same time, record low-interest rates for more than a decade have fuelled a growing dangerous situation: rising debt and especially corporate debt. According to Bloomberg, there is now a record $250 trillion of debt worldwide which amount to roughly 3 times the global GDP. In the US alone the corporate bonds market is valued at nearly $10 trillion which is almost 50% of US GDP. Currently, debt funding is a lot cheaper than equity funding and it makes sense for corporates to borrow, rather than sell equity. And the promise to keep interest rates low can only exacerbate this trend.
The tricky bit is that if and when the economy starts to deteriorate, a snowball effect could be set in motion. The credit rating agencies will start downgrading corporate debt, which will increase the number of forced sellers and in turn will attract debt refinancing difficulties. Ongoing low rates are, for now, postponing the day of reckoning, especially for zombie companies bordering profitability but it will not stay like that forever. S&P 500 companies are in a better financial position but it’s hard to believe they would not be affected by the selloff if that scenario comes true.
On Friday the US will release its nonfarm payrolls report which is expected to show the economy added 186,000 jobs with the unemployment rate remaining unchanged at 5.5%. If those numbers are confirmed, or surpassed, then the S&P 500 could potentially attract buyers, as it would indicate the US employment market is still in good shape.
But what does the chart show?
Overall S&P has been in a healthy uptrend with higher highs and higher lows. Additionally, the current market price is not far off the all-time high of 3157 reached on December 2. After making that new record high it had a bit of a retracement, but the rally looks set to resume.
What’s interesting is that the 9-week moving averages (red line) acted as good support attracting fresh buying power. Both moving averages, 9MA and 21 MA point upwards and the shorter one sits comfortably above the longer one. So the short, medium and longer-term outlooks are all bullish. However, if the second part of 2018 is to offer any warning, things can also turn to the downside rather quickly. S&P gave back over 600 points (more than 20%) during that period.
On the downside, we see support around 3070 followed by 3020 and 2950 but for now, as the saying goes ’the trend is out a friend’, so we can sit back and enjoy the ride.