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Assessing Scenarios and Opportunities of an Inevitable S&P 500 Break

Assessing Scenarios and Opportunities of an Inevitable S&P 500 Break

John Kicklighter, Chief Strategist

Talking Points:

  • The S&P 500 managed to post record highs four days this past week, including Friday's close at approximately 2,500
  • Despite its record highs, progress has all but collapsed with the smallest 4-day range for the index on record
  • A break is inevitable - especially with the FOMC ahead - but trade opportunity depends on severity and direction

How have the DailyFX third quarter forecasts for the S&P 500 and other global equity indexes held up to so many unusual developments these past months? Download our fundamental and technical outlook for the benchmarks of this asset class.

The S&P 500 will see a meaningful technical break in the week ahead. However, the trading potential this inevitability presents depends on the circumstances surrounding the break. Looking at how the benchmark US equity index closed this past week, we can see the tension registered as readily as the dichotomy in speculative conviction. On the one hand, the S&P 500 is at record highs. In fact, the index closed at fresh record highs four of the five trading days this past week and eventually ended at the psychologically important 2,500 mark. That said, the conviction in extending this drive in confidence securing such a remarkable milestone looked exceptionally tepid when registering momentum and appetite across the financial system.

Despite its highs, the S&P 500's drive was defined by a four-day range Tuesday through Friday that was a record for inactivity. The four-day range was only 0.39 percent of Friday's spot close. That is unprecedentedly quiet for this market. To a certain extent, quiet can be reassuring as an indication of confidence. Yet, these market reflect less of the assurance that specific scenario would insinuate and more of the high-risk complacency that has permeated the speculative rank over the months. We can see that doubt in other areas related to the risk appetite that is supposedly carrying US equities higher. A direct contrast can be found in speculative positioning. Traders' positioning in the broad Russell 2000 for example has seen a tumble to a net short exposure last seen during the Great Financial Crisis according to recent Commitment of Trader data from the CFTC. More generally, the quality of investor confidence is undermined by the uneven performance of so many other risk appetite-dependent assets. Global equity indexes, carry trade in the FX market, higher-yielding asset classes and more are much further from their respective highs or are in some instances moving in the opposite direction.

The fear of a financial system that is overexposed to risky assets in search of increasingly tepid returns is a sentiment that is now commonplace even among those participants that are all-in on risk. Yet, that doesn't mean that a reckoning is at hand in the week ahead. As the saying goes, 'the markets can remain irrational longer than you can remain solvent'. Reasonable and fair value are what the speculative masses determine it to be. That demands flexibility in our approach to next week, but a short-term break for the S&P 500 is almost certain. The historically low activity level on such a recognizable benchmark is an anomaly that will not persist. The first degree of strategy is whether there is a break of 'necessity' or 'conviction'. The former refers to simply a technical development that is a result of a market that has simply run out of navigable room. While it can potential gain traction and momentum by mere virtue of it being such a high profile index, it will be a struggle to sustain - especially with so much high profile event risk and so many themes influencing the system recently.

A break of conviction - one driven by key event risk like the FOMC decision - are more likely to catalyze deeper fundamental interest and coopt various motivations to the same end. In either market type, a bullish break will face the inevitable skepticism that a richly priced market already carries. Alternatively a bearish resolution can generate more momentum and even motivate a systemic risk aversion. We discuss the risk and trading opportunities that will revolve around the S&P 500 in this weekend Quick Takes video.

Assessing Scenarios and Opportunities of an Inevitable S&P 500 BreakAssessing Scenarios and Opportunities of an Inevitable S&P 500 Break

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