Thu, Oct 21, 2021 @ 18:12 GMT

It Only Goes Up

The S&P500 hit its fifth consecutive all-time high on Monday, regardless of the most recent inflation report confirming sticky and high inflationary pressures, and growing Covid worries, which threw the UoM’s sentiment index to a decade low level in August.

But there is no stopping the US equity rally and although it’s disquieting, strong corporate earnings, low US yields and a relatively soft US dollar are the major catalysts for the US market rally. But the cliff between the economic indicators and the equity prices is somewhat unreasonable, hinting that there is potential for a sizeable downside correction. But when?

What could possibly derail the equity rally?

High inflation? Yes and no. High inflation means a sooner Federal Reserve (Fed) tightening, but the Fed’s hawkish shift is mostly digested by investors. We know that the Fed wants to start tapering its bond purchases sooner rather than later because of high inflation and solid jobs data. Therefore, the announcement of Fed tapering will sure dampen the mood but would hardly trigger a 5-10% downside correction across US equities.

A more hawkish Fed? Possibly, yet there is little chance of seeing the Fed do more than start tapering its bond purchases. The first Fed rate hike is scheduled in 2023 and investors will continue surfing on the low US rates for a couple of more months. US equities will remain appetizing as long as the US 10-year yield remains below the 2% mark.

Soft economic data? Well, that’s the most plausible cause for an eventual downside correction in the close future, as the combination of rising Covid cases and soft economic data would mean that the companies must deal with a prolonged period of unfavourable economic conditions, but with less financial support from the Fed which also needs to deal with the high inflation, as a result of the massive cash thrown to the market so far.

Due today, the US retail sales are expected to have retreated by 0.2% m-o-m in July. A slightly negative read may not discourage investors, as the sales jumped 28% y-o-y in March, 51% in April, 28% in May and near 18% in June. Therefore, a minor slowdown in recovery shouldn’t dent the risk appetite. Unless we see a surprisingly negative number, which would point at a faster-than-expected slowdown in recovery, there is nothing that could stop the US stock bulls from flirting with new highs.

Except from the energy stocks, as oil prices remain under a decent selling pressure. We see solid resistance forming above the 100-day moving average, a touch below the $68 per barrel, on the back of worries that the rising Covid delta contagion will likely slow down the global economic recovery and dent prospects of a strong global demand. Technically, the $66 level is an important support as it is the baseline of the positive trend building since March. A move below this level could pave the way for a further downside correction to the $60 pb mark, the 200-day moving average. The latest news and the market sentiment hint that we have a greater chance of seeing a move to the $60 pb level, rather than one back above the $70 pb.

 

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