U.S. Stocks Rally with Blinders
Andrew Hecht of Dynamic Commodities - InsideFutures.com - Fri Aug 10, 8:45AM CDT

This article was originally published on Nadex.com.

Over the first six-weeks of 2016 the S&P 500 index posted around a 13 percent loss, but the buying returned, and it was off to the races throughout that year, 2017, and into 2018. Stocks rallied despite the shock of the Brexit referendum in June 2016 which only caused a temporary and modest downside correction. In November 2016 a surprising result in the U.S. Presidential election resulted in a downward move that lasted just hours. 

Source: Barchart

As the chart of the index highlights, the S&P 500 rose to its most recent high in late January 2018 at 2,872.87. In early February, the index experienced a downside correction that took it to lows of 2,532.69, an almost 12 percent drop. However, the market seems to be proving more resilient than in early 2016 as it rallied back to above 2,850 level in early August and it appears to be heading for a new and higher high. Corporate tax reform in the United States has turbocharged earnings for companies translating to higher share prices and fueling economic growth in 2018. The latest GDP numbers for the second quarter of 2018 showed growth of 4.1%, the highest rate since 2014. Moreover, optimism has prevailed in the stock market given the business-friendly administration in Washington DC.

While the bullish factors pulling the stock market higher have been a dominant force, the equities market has ignored some dark and foreboding bearish clouds over recent weeks which could cause volatility in the asset class to increase dramatically through the second half of 2018. There are three significant issues facing stock prices that could force the market to remove those bullish blinders.

The prospects for rising U.S. interest rates were the cause of the latest corrective move in stocks at the beginning of February. Bonds are fixed income products that compete with equities for investment capital. When bond prices fall, interest rates rise, and money tends to flow into fixed income products at the expense of stocks. Both short and long-term rates in the United States have been rising as a result of economic growth and growing inflationary pressures. The Federal Reserve has already hiked the short-term Fed Funds rate twice in 2018, and at their June meeting, they told markets that two more increases could be coming by the end of this year which would put the rate at 2.25-2.50 percent. At the same time, the central bank is reducing its balance sheet by allowing the legacy of quantitative easing to roll off on a monthly basis putting upward pressure on rates further out on the yield curve. The prospects for higher rates could weigh on stocks over the coming weeks and months.

The second issue hanging over the equities market is the trade dispute between the U.S. and China. A prolonged trade war with the world’s most populous nation with the send highest GDP could have recessionary implications which could send stock prices lower.

Finally, during the Q2 earnings season we witnessed some cracks in the bullish armor for some of the most popular and widely held stocks as the prices of Facebook and Twitter moved appreciably lower after disappointing earnings reports. The weakness in two of the so-called “FAANG” stocks could be an ominous warning for the equities asset class.

U.S. stocks continued to rally into early August, and they are once again approaching record territory. However, some of the dark clouds on the horizon could mean that increased volatility and more trading opportunities could be on the way in the stock market as corrective moves favor nimble traders rather than passive investors.

 

 

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