The S&P 500 Set a New All-Time High… Now What?

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It’s official. It took 126 days after plunging to its 52-week low on March 23 for the S&P 500 to set a new all-time closing high of 3,389.78.

A digital image of a bronze bull and bear overlaid with a technical chart and images of coins.

Source: Shutterstock

This is the fastest the S&P 500 has ever recovered from a bear-market pullback. The previous record was 310 days, and the average recovery has taken a whopping 1,542 days.

Needless to say, 2020 continues to shock and surprise.

Great … so the S&P 500 has erased all of its novel coronavirus losses. Now what?

We think the index is going to continue moving higher for three reasons:

  • The Federal Reserve’s accommodative monetary policy
  • The European Union’s new common bonds
  • Additional fiscal stimulus from the U.S. Congress

Federal Reserve’s Accommodative Monetary Policy

The Fed reacted quickly to the negative effects of the Covid-19 pandemic, and it has been steadfast in its commitment to supporting the U.S. economy. It has dropped interest rates to nearly zero, spent billions on asset purchases and provided liquidity for the markets and businesses.

This has led to record-low interest rates in the Treasury market.

Now, while low interest rates are a great thing for borrowers, they’re not so great for investors.

Borrowers — like businesses looking to expand operations or consumers looking to buy a new home — prefer low interest rates because it makes borrowing cheaper. It’s much easier to pay back a mortgage with an interest rate of 2.75% than it is to pay back a mortgage at 5%.

Investors, on the other hand, like high interest rates because they get a bigger bang for their investment buck. It’s much more fun to watch your fixed-rate savings expand at 4% than it is to only earn 1% on your money. This is especially true when the rate you’re able to earn on your investment is lower than the rate of inflation.

You see, investors know that the nominal rate of return — the interest rate they are earning on their investment — only tells part of the story. They also want to know what their real interest rate — the nominal rate minus inflation — is because money is only as good as the goods and services it can buy.

When the inflation rate is lower than the nominal interest rate, the real interest rate is positive. In other words, the return you are making on your investments is outpacing inflation.

Conversely, when the inflation rate is higher than the nominal interest rate, the real interest rate is negative. This means the return you are making on your investments isn’t even keeping up with inflation, which means you are losing spending power.

Typically, when investors see their real interest rate on a particular asset dipping into negative territory, they start moving money out of that asset and into assets with higher real interest rates — even if those assets are a little riskier.

When forced to choose, unless panic is gripping the markets, investors will usually take on more risk in search of higher returns.

We’re seeing this right now. More investors are moving money out of longer-term Treasurys and into stocks. They’re being forced out of Treasurys because real interest rates are dipping farther and farther into negative territory.

You can see this dip in the monthly chart of the 10-Year Treasury Inflation-Indexed Security in Fig. 1.

Source: FRED Charts

Fig. 1 — Monthly 10-Year Treasury Inflation-Indexed Security

Real interest rates dropped below zero in late January and are now at their lowest levels in decades.

Even during the last recession in 2008 and 2009, the real interest rate remained positive, making longer-term Treasurys look much more attractive than they do now.

It took until late 2011 for real interest rates to drop below zero during the last economic cycle. And by that time, investors were more than happy to move money into the bullish stock market.

So long as the real interest rate for Treasurys remains below zero, investors will continue seeking higher yields in the stock market.

European Union’s New Common Bonds

In late July, the EU took a huge step toward further integration among member countries. It sold common bonds.

This is not the first time the EU has sold common bonds, but this is the largest amount of common bonds the organization has ever approved — 750 billion euros worth, to be precise.

In the past, each country has been free to sell its own bonds and use the proceeds domestically. Now, to supplement those national bonds, the EU is selling common bonds and will be distributing the proceeds to member countries based on need, not proportionally based on the size of each country’s gross domestic product (GDP).

For all you Hamilton fans out there, this is similar to what Alexander Hamilton was trying to do when he proposed the federal government assume the debt the states had accumulated during the Revolutionary War.

It may seem like a small step, but it shows the EU is willing to tackle the Covid-19 pandemic with more aggressive fiscal stimulus as a supplement to the monetary stimulus the European Central Bank (ECB) is providing. This should help stabilize the European economy and boost corporate returns.

Additional Fiscal Stimulus from the U.S. Congress

While the European Parliament was able to come together and agree to issue new common bonds, the U.S. Congress is still dithering over details for its next fiscal stimulus package.

However, with increasingly desperate calls for more stimulus from states, voters and corporate leaders at Walmart (NYSE:WMT) and other Fortune 500 companies, we believe Congress is ultimately going to follow up President Donald Trump’s executive orders with a new package of its own.

It appears Wall Street is already pricing in an agreement. We don’t think the S&P 500 would be at a new all-time high otherwise. Now we’re just waiting to see how aggressive the stimulus package ends up being.

The Bottom Line on the S&P 500

We wouldn’t be surprised to see some profit-taking that causes some consolidation now that the S&P 500 has recovered its Covid-19 losses. However, we don’t think the index is done climbing.

But how high can it go?

Projecting new all-time highs is always an imprecise venture, but we have found it’s never a good idea to fight the current trend. That’s why we like using Fibonacci extensions to help provide some guideposts as to where the trend may go in the future. It’s an indicator that works with the trend, not against it.

As you can see in Fig. 2, we applied a Fibonacci extension to the bullish run the S&P 500 made from late March through early June, before the index started to consolidate for a month.

Source: Chart by TradingView

Fig. 2 — Daily Chart of the S&P 500 (SPX)

Based on this move, the next bullish target for the S&P 500 is 3,603.82.

Now, don’t let the precision of that number fool you into thinking it is more accurate than it is. We’ll simply be watching the range around 3,600 as our next target. And considering how quickly the S&P 500 moved the 200 points from 3,200 to 3,400, it may not take long at all to climb from 3,400 to 3,600.

John Jagerson & Wade Hansen are just two guys with a passion for helping investors gain confidence — and make bigger profits with options. In just 15 months, John & Wade achieved an amazing feat: 100 straight winners — making money on every single trade. If that sounds like a good strategy, go here to find out how they did it. John & Wade do not own the aforementioned securities. 

The post The S&P 500 Set a New All-Time High… Now What? appeared first on InvestorPlace.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.


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