With the S&P 500 climbing up to new all-time highs again and again, many traders are wondering how much higher stocks can go, especially when the bond and currency markets are decoupling from the stock market.
In the aftermath of the presidential election, the S&P 500 (.INX), the U.S. Dollar Index (DXY) and the 10-year Treasury yield (TNX) all jumped higher because traders around the world expected that the Donald Trump administration was going to “reflate” the economy with a tax overhaul, infrastructure spending and regulatory reforms.
Traders pushed stock prices higher with the expectation that corporate earnings would increase with a stronger economy. They also pushed Treasury yields higher with the expectation that inflation would increase and the Federal Open Market Committee (FOMC) would be forced to raise rates at a faster pace. Finally, they pushed the U.S. dollar higher with the expectation that economic growth and interest-rate hikes would happen sooner in the United States than in other countries around the world.
Unfortunately, the anticipated changes haven’t materialized yet, and traders are responding.
If you look at the chart in Fig. 1, you’ll see that the DXY (blue line) was the first to reverse course after its post-election bullish surge. From the beginning of 2017, DXY has been losing ground as the U.S. has failed to significantly outperform its global peers.
Fig. 1 — SPX, TNX and DXY Comparison Chart
The TNX (red line) reversed course a few months after DXY started moving lower when traders realized inflation wasn’t picking up like they thought it would and the FOMC may not have to be quite so “hawkish” with its monetary policy.
Interestingly, the SPX (black line) is still moving higher. While the TNX and DXY are in established downtrends, the SPX is continuing to form new all-time highs.
So why the disconnect?
It appears that even though the economy hasn’t grown at the 3%-4% rate that President Donald Trump promised, it is growing steadily enough for corporate America to continue generating solid returns. In fact, this past earnings season saw the strongest year-over-year earnings growth (13.9%) the S&P 500 has seen since the third quarter of 2011.
Add to that the fact that as Treasury yields drop, dividend yields become all the more attractive, and you’ve got a recipe for money flowing into the U.S. equity market, pushing stock prices higher.
The Bottom Line on the S&P 500
As long as companies keep buying back their own stock, the U.S. economy continues its slow and steady growth and Treasury yields remain low, the S&P 500 still has plenty of room to move higher — barring any unforeseen geopolitical shocks to the system.
After all, where else are traders going to put their money? The U.S. equity market still offers the best risk-adjusted bang for your buck on the planet.
InvestorPlace advisers John Jagerson and S. Wade Hansen, both Chartered Market Technician (CMT) designees, are co-founders of LearningMarkets.com, as well as the co-editors of SlingShot Trader, a trading service designed to help you make options profits by trading the news.
John and Wade have now launched Turbo Trader Live — a live, interactive trading room service that focuses on technical analysis, long options and vertical spread strategies to help investors like you lock in fast and consistent profits with less risk. You can learn more about identifying price patterns and using them to project how far you think a stock is going to move in our Advanced Technical Analysis Program.
