S&P500 at Support: bounce or freefall?

Back in June, we asked if the S&P500 would be breaking out soon…

This was how it looked at the time:

And break out it did! Here’s the after…

A solid breakdown below that prior low at 3810 saw further downside in the S&P500, before rallying from the low at 3635. That rally was capped by the 20 day moving average and the market is now retesting the 3810 zone from above.

Bulls will want to hold this area and try to push on to the next objective in the 4100 zone. Given the pace of the decline this year, a countertrend move can’t be ruled out if seller exhaustion meets increasingly confident buyers…

Still, it’s hard to make the case that “the lows are in”, especially as central banks continue to hike interest rates in their battle to put the inflation genie back in the bottle.

Higher interest rates increase the appeal of bonds and other assets vs equities. In a low interest rate world, equities were seen as the best bet, but there’s no guarantee that we’ll be returning to that world any time soon.

Even in Europe, once thought to be irreversibly following Japan into an economy driven by deflation, rate hikes are being lined up.

Yesterday’s inflation data provided no relief for the ECB either. Spanish headline inflation hit 10.2%, well above expectations. Germany’s CPI figure came in lower but this was largely due to travel subsidies rather than a genuine shift of inflationary pressures.

European Central Bank President Christine Lagarde appeared on a panel with Fed Chair Powell and said that she doesn’t think

“that we are going to go back to that environment of low inflation”

“There are forces that have been unleashed as a result of the pandemic as a result of this massive geopolitical shock we are facing now that are going to change the picture and the landscape within which we operate”

All else equal, the longer inflation remains high, the longer interest rates should remain higher too. Which is a pretty big headwind for equities over time. There’s also a risk that the combination of higher costs and a more cautious consumer will eat into company margins…

JP Morgan analysts downgraded 26 tech stocks yesterday including Alphabet, Amazon, Meta, Netflix, Snapchat & Twitter. They argue that the rising risk of a recession could see a pullback in online advertising and ecommerce.

This really isn’t a strong macro backdrop for equity markets, but these concerns are nothing new either. At some point, the rising risk of a recession could force the Fed and other central banks to pause their hiking cycles and let the recession do the inflation-bashing for them, before returning to the old regime.

Federal Reserve Chair Jerome Powell didn’t sound so sure about that…

“Since the pandemic, we’ve been living in a world where the economy has been driven by very different forces,”

“What we don’t know is whether we’ll be going back to something that looks more like or a little bit like what we had before -- we suspect it’ll be kind of a blend. We’re learning to deal with it. We’ve lived in that world where inflation was not a problem. I think we understand better now how little we understand about inflation.”

A brand new world…

Not investment advice. Past performance does not guarantee or predict future performance.