The S&P 500: A New Bull Market Is Born
Summary
- The S&P 500 flirted with 4,200 resistance for a while, but above 4,200, a new bull market is born (20% plus gains off the low).
- In addition to the constructive technical conditions, the fundamental backdrop is improving.
- Inflation has dropped from its highs, the labor market remains strong, and the Fed's plan is actually working.
- In addition, corporate results are robust, the resilience of corporate America is remarkable, and we could see a shift toward easier monetary policy as we advance.
- The bear market likely ended last October, and future corrections should lead to compelling buying opportunities.
- This idea was discussed in more depth with members of my private investing community, The Financial Prophet. Learn More »
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The S&P 500/SPX (SP500) and stocks, in general, passed a crucial week and are heading into the final days of May, with the market around its highest level in nearly a year. Other critical market averages like the Nasdaq 100 are in new bull markets and are trading around their highest levels not seen since early 2022. Additionally, a move above 4,200 places the SPX in the pivotal 20% (gain from the bottom) range, suggesting that the most widely watched stock market index is entering a new bull market here. Furthermore, the Fed is not likely to continue raising the benchmark rate. On the contrary, we could see increased dovishness as the Fed moves toward a "pivot" in its monetary stance.
Also, we've seen significant progress on inflation, and the economy is not falling off a cliff. While several economic indicators have come in worse than anticipated, the economy is holding up relatively well considering the downturn. Therefore, there is a high probability that the worst is behind us. While corrections and pullbacks remain everyday market phenomena, the bear market low of 3,500 in the SPX could be the low level that sticks. Thus, weakness on pullbacks should present buying opportunities, and we could end the year significantly higher in many high-quality stocks.
Above 4,200 - A New Bull Market is Born
The SPX recently went over 4,200, a crucial resistance point. The 4,200 level represents the 20% mark, implying that a new bull market started around the low of 3,500 in mid-October of 2022. While we did not get the textbook panic-selling, capitulation-style bottom we witnessed in some other bear markets, we saw other signs of a market bottom.
October's sharp reversal was akin to an intermediate or a long-term market bottom as SPX opened around 100 points below the previous day's close, reversing sharply during the session and closing around the highs. Moreover, we've seen bullish higher lows and higher highs since the new bull market began. Additionally, we saw another bullish signal as the 50-day MA moved above the 200-day MA in early February.
We've seen critical support levels around 3,800 and 4,000 holding up well recently. While some technical indicators illustrate that the market may be overheated in the near term, the RSI is around 60, implying that the stock market is not overbought here yet. Next, we should see a move toward the 4,350 resistance level, and if the SPX remains in the 4,200-4,350 consolidation zone, we should see stocks continue their outperformance as we advance into the fall.
The Scariest Thing For Markets
The scariest thing for the stock market may be the threat of tight monetary policy and its effect on liquidity and other crucial factors concerning stocks. However, the Fed's target rate is 5-5.25%, which may be as high as it will go.
Target Rate Probabilities
Target rate probabilities (CMEGroup.com)
There's about an 87% probability that the Fed will leave rates untouched at the next FOMC meeting in about three weeks. Moreover, looking out to the end of the year, probabilities indicate that the benchmark will likely be in the 4.25-4.75% range as 2023 ends. Therefore, there is about a 95% probability that the benchmark rate will be 25 Bps or lower than it is now when the year ends. Thus, the market expects 1-3 25 Bps rate cuts by year-end. This fascinating dynamic illustrates that the Fed will likely continue pivoting toward easier monetary policy as we advance.
The Highly Resilient Economy
The economy's ultra-high resilience is quite remarkable. Despite several red spots in the economic data, the most critical elements continue moving in the right direction. First, inflation has dropped recently, illustrating that the Fed's plan is working and that the tightening process is likely close to ending. Second, despite the economic turmoil, the labor market remains strong.
Payrolls Report
Payrolls report (Investing.com)
The most recent payroll report was much better than expected. The economy added 253K jobs, approximately 40% above consensus estimates. Private payrolls came in about 43% above the consensus estimate, illustrating that despite some economic headwinds, the private sector continues to power ahead. Also, the unemployment rate dropped to just 3.4%, and average hourly earnings topped estimates, coming in at 4.4%. Thus, we see continued strength in the labor market, and the economy continues functioning at a high level despite higher interest rates. Moreover, as the Fed's tightening cycle concludes, we could see increasing strength in the labor market and other key economic statistics.
Inflation - The Fed's Plan Works
CPI inflation (Tradingeconomics.com)
We've seen remarkable progress on inflation over the last year. Due to the Fed's tight monetary stance, CPI inflation has cratered from a 40-year high of 9.1% to just 4.9% last month. While 4.9% CPI inflation is relatively high, we should continue seeing inflation moderate as the economy moves on. Therefore, we should see 3-4% inflation soon, and if inflation doesn't come back down to 2%, it's okay.
The Fed's target rate of a long-term 2% inflation policy may be outdated, as achieving the target rate often requires inflation overshooting to the downside, leading to increased market turbulence and other damaging elements. On the other hand, achieving the target rate often requires inflation to run too hot before cooling in time.
Therefore, we may be focusing too much on the 2% here, and different phases of the economic cycle may do better with a floating or a varying rate instead. Thus, as we advance, the Fed may pursue varying inflation rate targets depending on economic conditions and other factors. A 3-4% inflation rate makes sense here, but achieving a 2% inflation rate may be too aggressive now and could come with harmful unintended consequences.
Strong Corporate Results Despite Soft Economy
Corporate America remains incredibly resilient. Despite the economic slowdown, many companies provided stronger-than-anticipated earnings results and robust forward guidance. Notably, American tech titans Microsoft (MSFT), Apple (AAPL), Alphabet (GOOG) (GOOGL), Amazon (AMZN), and others continue outperforming and should provide more upside opportunities as we advance in the second half of 2023 and beyond.
The S&P 500 is Cheap Now
The S&P 500's P/E ratio is only around 18.6, with its forward estimate around 18.8. We're now looking at a P/E ratio of below 20, lower than 20.3 from one year ago. The Nasdaq 100 P/E ratio is around 28, with a forward P/E ratio of approximately 26.6.
However, we should see high-quality tech with significant growth prospects trading at a higher PE than the SPX. Therefore, the 28 Nasdaq 100 P/E ratio and the P/E ratio divergence between the important averages make sense. Also, the Russell 2000's P/E ratio is below 30 here, much cheaper than last year's 50 P/E ratio. The R2K's forward P/E ratio of just 22.5 makes the small-cap index appear reasonable. The DJIA P/E ratio (22.3) is also inexpensive, especially considering the 17.7 forward P/E estimate.
The Bottom Line: Yes, We Could Have a Correction
Pullbacks and corrections continue to be a normal phenomenon. Therefore, we could see a correction provide significant buying opportunities in the weeks and months ahead. Depending on which level the SPX corrects from, 4,200-4,350 resistance should enable a 5-10% pullback to bring the SPX down to about 4,000-3,800 support. This support level should provide compelling buying opportunities in many high-quality stocks as we advance into the second half of 2023. Therefore, I am elevating my year-end SPX target from 4,500 to the 4,500-4,700 zone.
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This article was written by
Hi, I'm Victor! It all goes back to looking at stock quotes in the old Wall St. Journal when I was a kid. What do these numbers mean, I thought? Fortunately, my uncle was a successful commodities trader on the NYMEX, and I got him to teach me how to invest. I bought my first actual stock in a company when I was 20, and the rest, as they say, is history. Over the years, some of my top investments include Apple, Tesla, Amazon, Netflix, Facebook, Google, Microsoft, Nike, JPMorgan, Bitcoin, and others.
Analyst’s Disclosure: I/we have a beneficial long position in the shares of GOOG, AMZN either through stock ownership, options, or other derivatives. 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.
I am long a diversified portfolio with hedges.
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