"It appears that signs of progress on the trade front, or a series of economic reports that suggest trade uncertainty is not weighing on the economy, is what investors are looking for to push the SPX through resistance in the 2,950 area."
-- Monday Morning Outlook, July 1, 2019
The outcome of the G-20 meeting in Osaka, Japan between Presidents Donald Trump of the U.S. and Xi Jinping of China did not yield a trade deal -- but investors perceived positive progress, as a tariff truce was announced and the two sides agreed to resume talks. With that, the S&P 500 Index (SPX - 2,990.41) finally made a convincing move through 2,950, an area that it has failed to overtake since first pushing toward it 10 months ago.
Ahead of the Fourth of July holiday and the Friday morning June nonfarm payrolls report, the SPX closed at 2,995.82, only 5 points away from the 3,000 millennium level. The payroll number came in well above expectations, but the report sent stocks lower, as the implied probability of a 50-basis point rate cut, according to the CME Group's website, went from 29% on July 3 to 0% by Friday morning.
The question begged here is, "How will the SPX behave around a brand-new millennium level?" Investors can reference only two other occurrences in which the SPX ventured into a new millennium point for the first time -- February 1998 and October 2014. The one similarity is that 1,000 and 2,000 came into play again months after they were first tested, but the action in the short term couldn't have been more different.
For example, the SPX burst through 1,000 like a hot knife through butter in February 1998, and rallied another 17% by mid-July. But by September that year, it had pulled back to retest 1,000.
Moreover, two bear markets beginning in 2000 and 2007 pushed the index back below the 1,000 level. As stocks finally recovered beginning in 2009, the action from August 2009 into June 2010 echoed that of 1998, with the SPX easily rallying above 1,000 again in August 2009, and retesting the area in June 2010 before saying goodbye to 1,000 for good.
And from the first test of 1,000, it would take 16 years for the 2,000 level to be touched for the first time. But the first endeavor into the 2,000 area ended badly for short-term bulls, very much unlike the initial venture into the 1,000 area. After an early September 2014 first touch of the 2,000 level, the SPX experienced a mild retreat from this level for two weeks. Its first close above 2,000 on Sept. 18 proved short-lived, as the SPX traded as low as 1,820 in mid-October -- a pullback of about 9% in only a month's period.
For the next two years, the SPX never strayed too far above or below 2,000, and a pullback to this area in June 2016 began the next journey to the highs of last week, near 3,000. Though there are only two samples to work with, history has taught us that big short-term directional moves have occurred shortly after a first touch of a new millennium level, as is evidenced by the 17% advance just five months after the first touch of 1,000, or the 9% pullback only one month after the first close above 2,000.
"Fixed income exchange-traded funds in the U.S. attracted $25.4bn in June, the biggest monthly inflows on record, as investors piled into bonds amid an uncertain growth outlook."
-- Financial Times, July 1, 2019
"While Treasury yields could fall further this year, that won't necessarily help the stock market much, Goldman Sachs says...
"'While lower interest rates benefit equity valuations, the growth outlook has also weakened and uncertainty has risen,' the strategists wrote in a note. That is why the bank predicts the S&P 500 will rise just 0.6% to 3,000 by year-end, even if the 10-year Treasury yield slides to 1.75% as forecast."
-- Barron's, July 3, 2019
"Characterizing the stock market as a bubble is unsettling for investors because bubbles pop. But that's the direction where we're headed, Barclays says.
"'We believe that the 'Mini Bubble' scenario is now the most likely,' Barclays U.S. equity strategist Maneesh Deshpande said in a note to clients on Wednesday...
"If the 'Mini Bubble' were to happen, Deshpande estimates the S&P will surge to 3,260 by the end of the year. While this is his base case scenario, he assigns a 65% probability of a 'melt-up/mini-bubble' actually happening, and so he has an official S&P target of 3,000 (previously 2,750) with a somewhat stretched price/earnings ratio of about 18."
-- Yahoo Finance, July 3, 2019
The excerpts above (emphasis is mine throughout) explain additional reasons why the 3,000 area might be important in the coming weeks. For what it's worth, CNBC conducted a strategist survey in late June, and other firms with SPX price targets of exactly 3,000 include BMO, BTIG, and J.P. Morgan. Two others had year-end targets within 25 points of 3,000. One implication is that there could be major profit-taking in the weeks ahead if investors are adhering to these targets and share many strategists' belief that minimal upside potential exists in the second half of 2019.
Then there are the contrarian implications. For example, in the CNBC survey, only three of the 17 strategists have a target on the SPX that is above 3,000. In the context of the SPX hitting an all-time high last week, and a large majority of strategists seeing either downside or very minimal upside at best, a contrarian would play for a rally that exceeds expectations in the second half of the year and a breakout above the important 3,000 area.
Strategists aren't the only ones that have low expectations for the SPX, as investors have been slow to re-enter the market after June's recovery from the May sell-off. For example, there have been net redemptions when combining the inflows and outflows from the SPDR S&P 500 ETF Trust (SPY) and the Vanguard S&P 500 ETF (VOO) exchange-traded funds (ETFs). This is indicative of sideline money that has the potential to support stocks in the months ahead.
Clearly, bonds are currently the asset of choice among investors, as they choose to assume an uncertain outlook on growth means that the risk is skewed more to a slowdown in growth than a pick-up. This would in turn suggest that slowing economic growth would not be a huge surprise, leaving stocks less vulnerable as we move through the rest of 2019.
"More than 80% of S&P 500 companies that have revised their profit estimates one way or the other in the lead-up to reporting have slashed them, data compiled by Bloomberg show. Analysts are in on the action too, reducing company projections at the fastest pace in near three years."
-- Bloomberg, July 2, 2019
"Earnings Season Is Coming and Expectations Couldn't Be Much Lower"
-- Barron's headline, July 3, 2019
Finally, earnings season is around the corner. The number of companies reporting next week is light, but then it picks up gradually starting with options expiration week (July 15-19.)
In fact, FactSet reported in late June that 87 companies in the SPX issued negative guidance for the second quarter, above the five-year average of 74 and the highest since the 92 that did so for the first quarter of 2016. A low bar could give bulls something to look forward to in the weeks ahead, especially as the round 3,000 level lingers just above. An earnings season full of positive surprises amid lowered expectations could be the catalyst to push the SPX through the round number 3,000 area that many strategists have as a year-end target.
Todd Salamone is Schaeffer's Senior V.P. of Research.
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