The S&P faces two major tests that will make or break its short-term direction.
The first is its multi-month trendline.
As you can see below, the S&P is about to test the backbone of this year’s bull market.
This long-term trendline falls at roughly 4,260. With the S&P trading at 4,288 as I write Tuesday morning, we’re less than a percent higher.
If the S&P loses this support line, the trend break would suggest more weakness to come.
However, if we bounce, it would be a significant sign of strength. We’d likely see some emboldened bulls jump back into the market in expectation of a budding relief rally.
The second test would occur if the S&P fails the first test
In that case, we’d be looking to see if the S&P can find support at its long-term 200-day moving average (MA).
To make sure we’re all on the same page, a 200-day MA is a line on a chart showing the average of the prior 200 days’ worth of asset prices. It’s an important psychological line-in-the-sand for investors and traders.
When the asset’s price is above the 200-day MA, many traders interpret it as a sign that sentiment is bullish. The bearish opposite is true when asset prices are below this level.
Since many trading algorithms base their buy-and-sell decisions on the interplay between an asset’s price and its 200-day moving average, this is an important long-term technical level.
As you can see below, the S&P is barely 2% above this important 200-day MA.
If we lose this support level, we’re likely in for an acceleration of losses as risk-off sentiment spreads among traders.
Holding it and bouncing would open the door to renewed bullishness.
As to which way the market will break, keep your eye on the Toxic Trifecta
Here in the Digest, the “Toxic Trifecta” is the name we’ve given to the combination of the surging 10-year Treasury yield, the soaring cost of oil, and the climbing U.S. Dollar Index.
Today, we’re not seeing any meaningful relief from this damaging threesome.
As you can see below, the 10-year Treasury yield has been exploding, coming in at nearly 4.52% as I write. Back in April, it was as low as 3.25%.
(The chart below shows yesterday’s closing price.)
Over in the oil patch, though the price of West Texas Intermediate Crude is off its recent high of roughly $93, it remains at $89.
That’s plenty high to inflict pain on business operating costs and family budgets.
Finally, the U.S. Dollar Index continues climbing.
For newer Digest readers, the dollar index is a measure of the value of the U.S. dollar relative to the value of a basket of six major global currencies – the euro, Swiss franc, Japanese yen, Canadian dollar, British pound, and Swedish krona.
It’s now above $106, the highest level in six months.
Until we see a pullback in this Toxic Trifecta, the market will struggle to return to bullishness.
Luke Lango is laying the market’s recent underwhelming performance at the foot of the Fed
Luke is our hypergrowth expert and the analyst behind Innovation Investor. While most analysts were caught off guard by this year’s gains, Luke has been a roaring bull since late 2022. But in the wake of last week’s Federal Reserve meeting and Chairman Powell’s comments, he’s modifying his forecast.
Luke’s broad takeaway is that “until the Fed breaks from [it’s “higher for longer”] messaging, stocks will remain sluggish.”
Let’s jump to his Daily Notes in Innovation Investor for more:
Due to the Federal Reserve’s actions, it is our belief that the new trajectory for the stock market is cause for an update of our investment strategy.
In short, before the Fed’s hawkish commentary [last week], we were near-, medium-, and long-term bullish. We were bullish all around.
Now, after that hawkishness, we are short-term bearish but still medium- and long-term bullish.
Practically speaking, this means Luke isn’t recommending a “buy the dip” approach in the next handful of weeks. Instead, it’s a slightly tweaked approach: “Wait for the right moment to buy the dip aggressively.”
Luke and his team are monitoring the technical and fundamental trends underlying the stock market right now with the goal of identifying that “right moment.”
Here’s Luke:
…When it appears, we’ll let you know immediately – and go on a huge shopping spree.
Because a golden buying opportunity is coming.
How high is the market headed once bullishness eventually returns?
In answering this, Luke points toward earnings estimates and historical price-to-earnings ratios.
Back to Luke’s Daily Notes:
Earnings growth is expected to inflect from negative this year to positive next year and stay positive in 2025. That’s bullish.
If you run the math on those future earnings estimates, it becomes clear that – so long as those estimates prove true – stocks will soar over the next 15 months.
The 2025 EPS estimate for the S&P 500 is $290. The S&P 500 has averaged a forward earnings multiple of 17.5X over the past 15 years, and 20X over the past five years.
At the lower end, a 17.5X forward multiple on 2025 EPS estimates of $290 implies a 2024 price target for the market of 5,075 – about 16% above where we currently trade.
At the upper end, a 20X forward multiple on 2025 EPS estimates of $290 implies a 2024 price target for the market of 5,800 – about 33% above where we currently trade.
Either way, if 2025 EPS estimates are to be believed, then stocks have huge upside potential over the next 15 months.
To me, the key phrase from Luke is “so long as those [earnings] estimates prove true.”
And that brings us full circle to the Toxic Trifecta from earlier in today’s Digest
The 10-year Treasury yield, a loose proxy for borrowing costs, impacts how much companies must pay to finance their growth – affecting earnings…
The cost of oil directly impacts countless corporate Profit & Loss statements by pushing operating expenses higher – affecting earnings…
And the climbing U.S. Dollar undercuts the value of profits generated outside U.S. borders due to currency headwinds – affecting earnings…
The big question is “how much?”
If we see relief from the Toxic Trifecta as we head into 2024, then bullish earnings estimates have a far better shot at materializing.
Now, though we’ve just been talking about long-term earnings, our most immediate clue will come from Q3 earnings season that begins in two weeks with the big banks reporting. JPMorgan will post its results on Friday the 13th. Let’s try not to read anything into that date.
Here’s Luke’s market forecast to take us out:
We believe the Fed will shift toward dovishness, but it will take weeks (not days) and several weak economic reports (not just one) to get it to embrace such a stance.
Once it does, stocks will rally. But until then, stocks will remain choppy – hence our short-term cautious but medium- and long-term bullish outlooks…
But on a medium-/long-term basis, everything still looks very healthy.
So, just embrace this volatility because it will create opportunity. Not yet. But soon. And when the bottom does arrive – likely in October – the rally on the other side will be very big and very fast.
