“Uncertainty” — a word Wall Street loathes — seems to be the calling card of the market as we head into the third quarter of 2018.
Here is the stock market outlook for Q3:
The S&P 500 is still caught in an uncertainty-driven volatile consolidation range, and many are raising the warning that a full-blown bear market is right around the corner, yet miraculously, the index is actually trading higher for the year (see Fig. 1).
Fig. 1: Daily Chart of the S&P 500
Just imagine how well the index could be doing if traders weren’t waking up every morning to shifting news swirling around increasing trade-war rhetoric and were allowed, instead, to focus on economic growth in the United States and other bullish factors that still exist in the market.
Alas, that is not the world we live in. We live in a world dominated by a U.S. presidential administration that can take away (via threatened tariffs and import taxes) bullish sentiment from the stock market with one hand while giving (via domestic tax breaks and policy changes) that same bullish sentiment to the market with the other hand.
Below are a few sources of uncertainty we will be watching as we wait to see if the S&P 500 will be able to reach its full bullish potential this quarter, or if it will be riddled with doubt and experience a bearish pullback.
Trade War Uncertainties
The uncertainties surrounding a potential trade war with China, the European Union, Canada, Mexico and so on, have been plaguing the market all year.
Unfortunately, while we have seen the rhetoric from the Trump administration ebb and flow, the market still has no clear sense of what is going to happen next in this protectionist saga.
Will the various parties involved ease off from current threats, or will they escalate them? Nobody knows, and analysts are having a difficult time pricing in expectations because they change so frequently and haphazardly. If there is one primary albatross hanging around the market’s neck, it is the uncertainty surrounding how this trade war is ultimately going to play out.
Earnings
It’s earnings season again, and Wall Street has high hopes for Corporate America.
According to FactSet, analysts expect S&P 500 stocks to report year-over-year revenue growth of 8.8% and earnings growth of 20% for the second quarter of 2018. Those are big numbers, and the trouble with big numbers is that they are easier to miss. Earnings season is always a wild card, especially when you are already operating in a tenuous market environment. Traders may be less willing to give companies the benefit of the doubt if they miss revenue and/or earnings expectations, which could lead to more profit-taking in the aftermath of earnings announcements — a trend we saw develop this past earnings season.
Share Buybacks
It’s hard to find a company these days that isn’t plowing at least a portion of its tax savings and/or other revenue into a share-buyback program. Some companies, like Apple (NASDAQ:AAPL), plan to spend billions and billions ($100 billion in AAPL’s case), while others are only committing to tens of millions, but the trend is accelerating.
So long as companies keep buying back shares of their own stock, earnings per share (EPS) are going to get a positive boost because there are fewer shares across which earnings will have to be divided. If the size of these buyback programs starts to decline, however, watch for traders to scale back the price multiples they are willing to pay for earnings.
A Hawkish Fed
No matter what is going on in the market, there is always one player that can change the course of any trend: The Federal Reserve. Traders have been nervously watching the Fed’s Federal Open Market Committee (FOMC) all year for any sign that might indicate whether the committee plans to raise the federal funds rate three or four times during 2018.
If the FOMC only raises the federal funds rate three times, it means that both Wall Street and Corporate America will be able to enjoy a more accommodative monetary policy for a longer period of time. On the other hand, if the FOMC raises rates four times, borrowing costs will increase, margins will get squeezed just a little more and growth rates may slow, which would likely apply additional bearish pressure to the S&P 500.
As you can see in Fig. 2, traders are pricing in a 48.9% chance that the FOMC will raise the federal funds rate for a fourth time at its December 2018 meeting, which is much higher than the 34.7% chance that was being priced into the market just one month ago.
Fig. 2: Federal Funds Rate Probabilities
The Bottom Line for Next Quarter’s Stock Market Outlook
The U.S. stock market has the potential to continue climbing — if it can avoid getting derailed by the uncertainty that has been hampering it since early February.
We don’t think it’s time to throw in the towel on the long-term bullish uptrend we’ve come to know and love since the lows in March of 2009, but it is crucial to monitor market sentiment for signs of a turnaround just in case the S&P 500 decides to break below support at the 2,575 level.
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.
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