Will stocks continue climbing after setting a new all-time high? … three reasons John Jagerson and Wade Hansen see further gains coming … the next target level to keep an eye on
So, where does the stock market go from here?
That’s the underlying question for investors today.
On Tuesday, the S&P 500 closed at an all-time high for the first time since the Covid-19 pandemic hit the U.S.
It was an important psychological milestone in the wake of “the Covid bear,” which is the shortest bear market in history, at just 1.1 months.
On Wednesday, the S&P set a fresh high before retreating after minutes of the Federal Reserve’s policymaking body were released. They revealed concerns about the coronavirus’s continuing impact on the economy, pointing toward continued dampened growth and possibly broader dangers to the financial system. The S&P has largely moved sideways since.
As we look at the market today, hovering around all-time highs, it feels a bit like the old paradox of “what happens when the unstoppable force meets an immovable object?”
In one corner, we have a gravity-defying market surge, propped up by tech profits, powered by the Fed and an “infinite amount of cash” as Neel Kashkari, President of the Central Bank of Minneapolis, recently said.
In the other corner, we have the coronavirus, which continues stalking the U.S., leaving vast human and economic casualties, and historic unemployment, in its wake.
So far, the “unstoppable force,” which we’ll call the Fed and its infinite cash, seem to be winning (if victory is defined by an “up” stock market).
But some well-known market commentators believe the “immovable object” is about to reassert itself.
As one illustration, we have Jim Cramer, host of the popular investment show, Mad Money.
From Cramer on his show, earlier this week:
We’ve had a magnificent V-shaped recovery in the stock market, but the stock market’s not a great reflection of the broader economy anymore …
The actual economy is in precarious shape, especially now that the government’s stimulus package has run out and Congress went home for the summer rather than trying to come up with a replacement …
So, what happens now?
Will weakness in the broader economy end up stalling out, or even reversing, market gains?
Or will the economy find its footing, helping profits grow into today’s lofty stock market valuations?
In today’s Digest, let’s see what our technical experts, John Jagerson and Wade Hansen, have to say.
For newer Digest readers, John and Wade are the analysts behind Strategic Trader. In their service, they combine fundamental and technical analysis, along with historical market data, to profitably trade options in many different types of markets.
From their Wednesday update:
Great … so the S&P 500 has erased all of its COVID-19 pandemic losses. Now what?
Let’s find out.
***“We think the index is going to continue moving higher for three reasons”
Forgive me for spoiling the mystery with that subhead, but let’s just get to the good stuff.
John and Wade are cautiously bullish today. The first reason why is due to what’s behind the “unstoppable force” — namely, the Fed.
From John and Wade:
The Fed reacted quickly to the negative effects of the COVID-19 pandemic, and it has been steadfast in its commitment to supporting the U.S. economy.
It has dropped interest rates to nearly zero, spent billions on asset purchases and provided liquidity for the markets and businesses alike.
Before we move on, let’s make sure we’re on the same page about one aspect of interest rates.
With the Fed targeting rates of nearly zero, the difference between “nominal” and “real” rates becomes more important — and glaring.
The nominal rate of return is the face-value rate that investors earn on an asset. This is different than the “real” rate of return, which subtracts inflation from the nominal rate.
The real rate is what matters since inflation has a very real impact on the purchasing power of your dollars.
Let’s now return to John and Wade:
Typically, when investors see their real interest rate on a particular asset dipping into negative territory, they start moving money out of that asset and into assets with higher real interest rates — even if those assets are a little riskier …
We’re seeing this right now.
More investors are moving money out of longer-term Treasurys and into stocks. They’re being forced out of Treasurys because real interest rates are dipping farther and farther into negative territory.
You can see this dip in the monthly chart of the 10-Year Treasury Inflation-Indexed Security in Fig. 1.
Fig. 1 — Monthly 10-Year Treasury Inflation-Indexed Security — Chart Source: FRED Charts
Real interest rates dropped below zero in late January and are now at their lowest levels in decades.
Even during the last recession in 2008 and 2009, the real interest rate remained positive, making longer-term Treasurys look much more attractive than they do now.
John and Wade sum this point up by noting that as long as the real interest rate for Treasurys remains below zero, investors will continue seeking higher yields in the stock market.
***Reason #2 — European Union common bonds
Late last month, the EU took a big step toward further integration among member countries by selling common bonds.
Here’s John and Wade with more context:
In the past, each country has been free to sell its own bonds and use the proceeds domestically.
Now, to supplement those national bonds, the EU is selling common bonds and will be distributing the proceeds to member countries based on need, not proportionally based on the size of each country’s gross domestic product (GDP).
At 750 billion euros, this was the largest amount of common bonds ever approved by the organization.
John and Wade note this shows the EU is willing to tackle the COVID-19 pandemic with more aggressive fiscal stimulus. This is a supplement to the monetary stimulus the European Central Bank (ECB) is providing.
Now, why would the economic health of Europe impact U.S. stocks?
Simple — the S&P is a global index. By that, I mean that roughly 40% of the sales for the S&P are derived overseas.
Given this interconnectedness of today’s financial markets, a healthier European economy is a positive for U.S. markets.
***Reason #3 — Additional fiscal stimulus from Congress
From John and Wade:
… the U.S. Congress is still dithering over details for its next fiscal stimulus package.
However, with increasingly desperate calls for more stimulus from states, voters and corporate leaders at Walmart (WMT) and other Fortune 500 companies, we believe Congress is ultimately going to follow up President Trump’s executive orders with a new package of its own.
It appears Wall Street is already pricing in an agreement. We don’t think the S&P 500 would be at a new all-time high otherwise.
Perhaps the breakthrough might come from what appears to be increasing pressure within the democratic ranks to ease on package demands.
From The Wall Street Journal earlier this week:
“We cannot keep saying take it or leave it because we know very well at this point the Senate has left it,” said Rep. Cindy Axne (D., Iowa).
“I’m calling on Speaker Pelosi to bring up a revised federal aid package when the House is in later this week to continue our efforts to secure a deal that will help the millions of Americans still in need.”
One of the latest proposals from republicans is a “skinny bill” which, most notably, is expected to include $300 in weekly federal unemployment insurance through Dec. 27, while providing $29 billion in health-care funding.
***If the market continues climbing, where’s the next target level?
Before answering that question, John and Wade note that they wouldn’t be surprised to see short-term profit-taking.
That said, what’s the next target level for this rally from a technical perspective?
As you can see in Fig. 2, we applied a Fibonacci extension to the bullish run the S&P 500 made from late March through early June, before the index started to consolidate for a month.
Fig. 2 — Daily Chart of the S&P 500 (SPX) — Chart Source: TradingView
Based on this move, the next bullish target for the S&P 500 is 3,603.82.
Now, don’t let the precision of that number fool you into thinking it is more accurate than it is. We’ll simply be watching the range around 3,600 as our next target.
As I write Friday morning, the S&P is trading at 3,391. A move to 3,600 would mean another 6% gain.
But as John and Wade write:
… considering how quickly the S&P 500 moved the 200 points from 3,200 to 3,400, it may not take long at all to climb from 3,400 to 3,600.
Putting all of this together, it appears the “unstoppable force” is poised to continue besting the “immovable object.”
We’ll keep you up to speed as it plays out.
Have a good evening,