The Clash were an iconic power punk band who’s song “Should I Stay Or Should I Go” perfectly embodies investor sentiment as the S&P 500 approaches all-time highs yet again.
Bulls and bears alike both have valid arguments for stocks to move higher or drop lower from current levels. So as S&P 500 stocks continue to contemplate and consolidate, let’s take a look at the case for a bullish breakout or a bearish breakdown.
Bullish Breakout in S&P 500 Stocks
The uptrend in the S&P 500 continues to remain intact.
A series of higher lows since stocks bottomed in early June means buyers are stepping in on any meaningful drop. This is a decidedly bullish sign. Until the trend line is broken, S&P 500 stocks will likely continue higher.
Interest rates are near historic lows and likely headed lower.
The Federal Reserve is expected to cut rates once again at the October meeting. Fed fund futures are implying a 93% likelihood of a 25 bps rate cut to the target range of 1.5-1.75%. President Trump is pushing for the Fed to go even lower and perhaps even negative to match the European rate structure. The 10 year Treasury yield of 1.76% is lower than the 1.90% dividend yield on the S&P 500. This makes stocks, especially higher yielding ones with low payout ratios, comparatively more attractive.
Seasonality
The S&P 500 is entering the best two month period for historic stock returns. Since 1950 November has averaged 1.39% and December 1.35%. These are the two best overall monthly returns out of the twelve If history is any guide then S&P 500 stocks should be poised for a pop.
Bearish Breakdown in S&P 500 Stocks
Valuations
Currently, the S&P 500 sports a price-to-earnings ratio of 22.40, well above historic norms of 15.76. The forward P/E ratio of 17 is above both the 5- and 10-year averages. This P/E metric, however, has been muddied by massive corporate stock buybacks, which compresses the multiple. The much cleaner price-to-sales ratio paints a better and more alarming picture. The current P/S ratio for the S&P 500 now sits at 2.21 — the highest level ever. At some point valuations will matter.
Economic Growth
The Conference Board just lowered their forecast for the U.S. economy. They expect GDP growth to be just 2% from prior levels above 3%. They expect consumer spending to begin softening as well. Germany just lowered their economic growth forecast from 1.5% to only 1%. The Citigroup Economic Surprise Index peaked mid-year and is poised to go negative. Overall growth worldwide remains anemic at best. A recession is a distinct possibility and long overdue.
Earnings Decline
Factset expects the S&P 500 to report a year-over-year earnings decline of 4.7%. Net profit margins are projected to shrink for the third straight quarter. Corporate buybacks are at historic extremes and unlikely to continue to provide fuel the artificial P/E boost. Overall, the earnings backdrop is beginning to deteriorate — a decided negative for S&P 500 stock prices.
The S&P 500 is caught in no man’s land, stuck between the upside overhead resistance at $3,020 and the lower support at the trend line near $2,900. Traders can use those two levels as the catalyst for either a meaningful breakout or breakdown. The longer we wait and tighter we coil, the bigger the potential move when it does happen. Until then, patience pays.
Tim Biggam may hold some of the aforementioned securities in one or more of his newsletters. Anyone interested in finding out more about Tim and his strategies can go to https://marketfy.com/item/options-and-volatility.
