S&P 500: Getting Ready For A Run To 2550

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Includes: CRF, DDM, DIA, DOG, DXD, EEH, EPS, EQL, FEX, FWDD, HUSV, IVV, IWL, IWM, JHML, JKD, LLSC, LLSP, OTPIX, PSQ, QID, QLD, QQEW, QQQ, QQQE, QQXT, RSP, RTN, RWL, RWM, RYARX, RYRSX, SBUS, SCAP, SCHX, SDOW, SDS, SFLA, SH, SMLL, SPDN, SPLX, SPUU, SPXE, SPXL, SPXN, SPXS, SPXT, SPXU, SPXV, SPY, SQQQ, SRTY, SSO, SYE, TALL, TLT, TNA, TQQQ, TSLA, TWM, TWOK, TZA, UDOW, UDPIX, UPRO, URTY, USA, USSD, USWD, UUP, UWM, VFINX, VOO, VTWO, VV
by: Mott Capital Management

Summary

The market should have broken the week of April 3rd.

The underlying bid in the market seems strong.

If this past week didn't break it then what will?

On April 5th in the Reading The Markets Member section, I put out a video explaining my reasons for the S&P 500 (NYSEARCA:SPY) to reach 2550. In fact, on January 1st, I made a similar call. The week of April 3rd convinced me that the S&P 500 is about to enter the next leg higher on its march towards 2500-2550 in 2017. The biggest signal for the likely move higher in the S&P 500 actually came from the Bond and Currency markets over the last few days.

To begin to understand my strong conviction for the march higher for the S&P 500, we need to go back to April 5th. It was on that day that the Fed minutes were released. The minutes showed the Fed was beginning to think about potentially reducing the balance sheet towards the end of 2017.

(Interactive Brokers TWS)

We can see in the chart above the S&P 500 was up strongly for most of the day on Wednesday the 5th, before rapidly selling off following the Fed minutes and comments from Paul Ryan that Tax Reform could take longer than originally expected. These two developments were more than enough to send the S&P sharply lower into the close.

Let's first go through the three signs that signal the S&P 500 and the entire equity market is about to take its next leg higher, with signs from the Bond and currency market confirming it.

Sign 1

The first sign of the market's resilience came on the morning of Thursday, April 6th, when the S&P 500 opens. The sellers and the Short sellers could have easily come in and taken advantage of the previous day's turnaround and shift of momentum and pressured the markets lower. The buyers could have sat on their hands and let the market come in as well. However, that is not what happened; the market stabilized around the 2350 area and moved higher.

Sign 2

On Thursday Night, we found out that President Trump launched Tomahawk (NYSE:RTN) missiles into Syria. Any military action typically sends investors into a flight to safety. The knee jerk exaction was to push equity futures lower, while sending bond yields (NYSEARCA:TLT) and the Dollar (NYSEARCA:UUP) lower.

(Interactive Brokers TWS)

We can see in the chart above 10-year bond yields traded down to about 2.27, breaking some critical support levels around the 2.30 area. The morning of Friday, April 7th, the flight to safety failed to get yields down in the early morning, even after breaking support. This should have caused an avalanche of Bond buying pushing yield even lower.

Sign 3 - The Final and Most Important Sign

The third and final sign came on Friday morning as well, when the March BLS job report came in sharply lower than the ADP private report on April 5th, and below market expectations. The weaker than expected jobs report should have also sent yields lower, caused the Dollar to weaken, and sent the stock market down as well. The weaker than anticipated jobs report could have easily been seen as a sign of cracks in economic improvements.

The bad job numbers cannot be viewed as a case of good news is bad news either. If the markets had viewed the job results as a sign the Fed could further delay future rate hikes, 10-year yields should have fallen coupled with a weakening Dollar, which as we know did not happen.

Instead we got bond yields that rose, a stock market that held strong and a Dollar that strengthened.

Dollar Index

(Interactive Brokers TWS)

How Do We Interpret These Events?

The question is why did yields not move lower? Why did the Dollar strengthen and why is the market holding?

Fed Balance Sheet

Let start with Wednesday, the Fed minute announcement of dialing back the size of the balance would be QE in reverse. If the purpose of buying bonds was to drive down yields, then the unwinding of the balance sheet is Inverse QE. Inverse QE would unlock the bonds held on the Fed Balance sheet. The selling of the Bond would, in theory, add liquidity to the bond market, causing prices on Bonds to drop and yield to rise over time. Besides, increasing yields should help to strengthen the Dollar vs. our NIRP friends, the Euro and Yen.

Syria

Although the missile attack could be viewed as an uncertain risk, the market was clearly sending a message this event was a short-term event and one that was likely not to escalate.

Jobs Friday

The jobs market results on Friday came in way below estimates. One needs to remember that the unemployment rates from the Household data and the total non-farm payroll numbers come from the Establishment survey. Although the non-farm payroll numbers were disappointing, the Household survey appeared strong.

When we take a deeper dive into the Household data, we see the following table.

(Data from BLS.gov)

What we see in this survey is a significant increase in the number of employed, a sharp drop in the unemployed. Additionally, the population size saw only minimal growth in comparison.

Additionally, for the first time in nearly a decade, the U6 measure of unemployment fell below 9.0%.

One Final Possibility?

I mentioned this in a video on Friday, April 7th; It Should Have Broken But Held Strong. Will President Trump, so focused on job creation with a lackluster headline reported, cause him to get more aggressive in rolling out tax reform and fiscal policy. Does it cause him to put more pressure on Paul Ryan and the Congress to stop stalling and get things moving? It could certainly be a possibility.

Perfect Storm?

There was a perfect storm of events in a very short period of time starting on the afternoon of April 5th, culminating the morning of April 7th. An equity market that lacked a strong underlying bid should have been sharply lower Friday morning. The Syrian Missile attack and weak job report should have sent investor running into Bonds. The weak job report should have sent the Dollar sharply lower.

All these things should have happened but did not. It is a sign of a very strong underlying bid in the market and a very strong belief of the continued reflation trade. In essence, the Bond and Currency market are looking past the weak establishment data and events in Syria. Instead, they are telling you it is still expecting strong economic growth and reflation in the future.

One must ask themselves, if weak headline economic data and military action did not send the equity markets lower what will? It makes me feel more convinced than even before this week, the market is likely to continue its upward move higher.

2550?

So how did I come with 2550? It is pretty simple.

S&P 500 Daily

(Interactive Brokers TWS)

The white line I mentioned earlier, you can see in the chart above, has been part of a downtrend that formed in the middle of March. Meanwhile, the Green trend line traces back to February of 2016 and butts up against Brexit. Other than a slight period around the beginning of September, the green February of 2016/Brexit Trend line has held unyielding and the market has ridden that line higher. I think we are on the verge of that line pushing the market higher yet again.

In the next chart, we can see the thick teal line that is drawn along the tops of the market highs.

S&P 500 Monthly

(Interactive Brokers TWS)

It would seem from the S&P 500 current level the next logical stop would be to butt up against that teal line again, and as of right now, it takes the index to around 2500-2550.

S&P 500 Earnings Per Share TTM Forward Estimate Chart

S&P 500 Earnings Per Share TTM Forward Estimate data by YCharts

With current estimates for 2017 at $123 per share for the S&P 500, a value of 2550 would give the index a Forward P/E of 20.7. In fact, when you look at the S&P 500 P/E ratio historically on Trailing Twelve-Month basis, the market is not cheap currently, but it certainly isn't in bubble territory either.

S&P 500 P/E Ratio Chart

S&P 500 P/E Ratio data by YCharts

Conclusion

The underlying bid in the equity market seems incredibly strong. The Bond and Currency market were telling us loud and clear that the reflation trade is not dead. Friday should have been the day that broke the backs of the Bulls. Bond yields should have fallen, the Dollar should have cracked, and the equity market should have fallen significantly. That did not happen.

If bad news and a fear trade don't break the equity market's back, then I can't think of much that could at this point. It leads me to the conclusion that the equity market is on the verge of moving higher, while yields move up, and the Dollar strengthens.

Good luck bears; you are going to need it.

Check out our latest Reading The Market Video where we talk about the Tesla (NASDAQ:TSLA) secondary and the market's reaction.

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Disclosure: I am/we are long TSLA.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Mott Capital Management, LLC is a registered investment adviser. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Upon request the advisor will provide a list of all recommendation made during the past twelve months. Past performance is not indicative of future performance.

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