Look Ahead: Equities
Investors have piled into equities over the past five days, causing the major U.S. indices to turn higher for the year after a downbeat start. There was no single stand-out catalyst behind this turnaround. After all, the United States fourth quarter earnings season has so far been a poor one, especially if you exclude the likes of Apple and Twitter from the list. On top of this, the political situation in Greece has deteriorated while there is no end in sight for the troubles in Ukraine or across the Middle East. Against these backdrops, one would have expected equities to underperform. But these are not normal times, with central banks continuing drive down yields by means of cutting interest rates or by using unconventional policy tolls such as quantitative easing. As the Fiancial Times reported on Thursday, some 542 rate cuts have now been recorded since the collapse of Lehman Brothers in 2007 and this number may get even larger as the global economy fights threats of deflation.
Therefore, it looks like yield-seeking investors are simply left with little choice but to continue what they have been doing ever since the central banks’ “race to the bottom” started: pile into equities. Admittedly, the Eurozone economy is showing signs of growth and things are looking bright in the UK, too. In the United States, the macro picture was beginning to look not-so-strong following the release of mixed-bag data. But on Friday we had a stellar jobs report that showed among other things a surprisingly large 0.5% jump in earnings growth. So the equity bull market is not totally unjustified. But are we climbing a wall of worry? Despite all the austerity measures across many European countries, the level of global debt has continued to outpace economic growth. According to research from McKinsey & Co, global debt has increased by $57 trillion since 2007 to almost $200 trillion today. This translates to 286% of GDP compared to 270% then, and more worryingly China’s debt relative to its economic size is now higher than that of the United States.
Nevertheless, stocks are continuing to push higher and the technical outlook for U.S. equities all of a sudden looks a lot brighter. Just at the start of the week, the S&P was threatening to break the neckline of a Head and Shoulders reversal pattern. However this pattern has now been invalidated after the buyers managed to defend the key 1980/90 support area successfully. As a reminder, this 1980/90 area corresponds with the 200-day moving average and also the 38.2% Fibonacci level of the last upswing. As the 38.2% represents a shallow retracement, it suggests that the next leg of the potential rally could be quite significant as the market is still evidently controlled by the bulls rather than the bears.
The S&P 500 has now broken out of the pennant consolidation pattern to the upside, as can be seen on the chart. Short-term speculators should watch the area around 2070 closely going forwards because this is where the previous couple of rallies had stalled. If the S&P 500 goes on to break through this area then it would clear the way for a move towards the previous record high of just under 2093. Beyond this, the next bullish targets would be the 127.2 and 161.8 percent Fibonacci extension levels of the last downswing, at 2125 and 2165 respectively. The near-term bias remains bullish unless the index goes on to break back below the 2025 support level. Should this happen then the way towards the above-mentioned 1980/90 support area would be cleared.