The US S&P 500 index firmed 2% last week, contributing to a 5% rise since the beginning of February. On the economic front this month, a better than expected consumer confidence reading for January may have provided a positive catalyst. Other favorable news has included the strong January non farm payrolls growth which comfortably exceeded consensus, despite a slight disappointment on the overall unemployment rate. The PMIs, which both came in above 50, bode well for economic growth in the US.
Less encouraging was the Q4 GDP growth which came in well under consensus. The January retail sales decline also disappointed. There were a number of other hits and misses during February.
Our current fair value modeling results give us cause to reflect on whether the recent strength in the S&P will be sustained in the short term.
Firstly, the 2% rise in the index over the last week outstripped the growth in fair value of 0.8%. The VIX and US 30 Year T-Bond rate being flat over the week, the drivers of the increase in the S&P’s fair value were generally positive moves in other major stock indices (which the S&P 500 outperformed) and a modest pullback in the US dollar index.
However, historically when the S&P’s price growth has exceeded the fair value growth over the previous week, this has foreshadowedsubsequent weakness – trading such signals over the last 90 days would have produced a 12% annualized gain.
Our estimate of the S&P 500’s fair value lies above the current price. However, as trading that disparity over the last 90 days would have produced a small loss we tend to discount that signal.
We have tested the propensity of changes in the Baltic Dry Index (BDI) to lead changes in key stock indices, currencies and commodities. The BDI change is widely considered a leading indicator of future economic growth (if the index is rising) or contraction (index is falling). We found a marked positive correlation between the BDI and S&P 500 index over the last six years.
With the 28% fall in the BDI over the last month, this bodes for some short term weakness in the S&P. Trading that signal over the last six years would have yielded an average annualized gain of 9.8%.
What to watch for:
How the release of the FOMC minutes, on Wednesday, moves the US Dollar Index and bond rates could impact the S&P 500 – any renewed strength in the dollar index could see some weakening in the S&P. Strength in EUR/USD (watch the PMIs coming out on Friday) has historically been correlated with weakness in the S&P and conversely.