Five Things That Could Drive Stocks Higher This Year

Five Things That Could Drive Stocks Higher This Year
Luke Suddards

over 1 year ago6 mins

  • The S&P 500 is looking primed for an upside move into year-end due to a number of different factors such as flows, positioning, technicals, fundamentals, and potentially a dovish pivot by the Fed.

  • The expected bullish move could be stopped in its tracks by a severe escalation between Ukraine and Russia, elevated inflationary pressures, or by or a technical break below 3,550.

  • The S&P 500 could see a rise toward the 4,000-4,150 range, which is where the 200-day simple moving average and range resistance sit.

The S&P 500 is looking primed for an upside move into year-end due to a number of different factors such as flows, positioning, technicals, fundamentals, and potentially a dovish pivot by the Fed.

The expected bullish move could be stopped in its tracks by a severe escalation between Ukraine and Russia, elevated inflationary pressures, or by or a technical break below 3,550.

The S&P 500 could see a rise toward the 4,000-4,150 range, which is where the 200-day simple moving average and range resistance sit.

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In investing, you always want to look for opportunities where the upside potential looks bigger than the downside. And at its current levels, the S&P 500 may be one of those – at least for the next few months. Let’s take a look at the five factors that are likely to drive the key US stock index higher between now and the end of the year…

1. Flows: where the money is likely to move.

The index is likely to see a rush of buying interest, mostly fueled by three types of market players. First are the rules-based traders known as Commodity Trading Advisors (CTAs): they’ve overall been betting against the index for a long time, and Goldman Sachs estimates we could see more than $200 billion in buying from these types of investors if the S&P 500 climbs from here. CTAs are trend-following, or systematic traders, who buy and sell based on price level breaks. Second are corporations: they’ve lately been amping up purchases of their own shares through a process called buybacks. Goldman estimates we’ll see a chunky $190 billion in this kind of buying over November and December, roughly $4.5 billion a day. Third are global investors: with the recent collapse in Chinese stock markets, they’re likely to redirect their capital back toward US equity markets – the cleanest dirty shirt.

2. Positioning: how speculative traders are currently placed.

Positioning among speculative traders – so, not buy-and-hold fund managers, but more of your opportunistic short-term players – is tilted significantly net short – in other words, these players have been betting that the S&P would fall. So, one of two things is likely to happen from here. With so many short positions already in place, that could limit how much lower these assets could fall, simply because there are fewer sellers. On the other hand, because so many traders are short, this could lead to a short squeeze, whereby the rising price forces those who were short a particular stock to rapidly close out their positions by buying the stock back, causing sharp upside price moves.

S&P 500 futures net positioning of non-commercial traders (speculators). Source: Bloomberg.
S&P 500 futures net positioning of non-commercial traders (speculators). Source: Bloomberg.

3. Technicals: what the signals tell you.

November and December tend to be good months for stocks.

Returns of the S&P 500 since 1928 from September to January 4. Sources: Bloomberg and Goldman Sachs.
Returns of the S&P 500 since 1928 from September to January 4. Sources: Bloomberg and Goldman Sachs.

And during a midterm US election year (like this year), the two months’ returns tend to be even better, with a median gain of 3% over the past 90 years.

Plus, the S&P 500 flashed a reliable signal at the end of September: its price had dipped to 20% below its 200-day “simple moving average” – i.e. the average price over the past 200 days. Over the past 100 years, that signal was followed by positive returns – except in 1931, 1937, 1974, and 2008. But even if you include those troublesome years, the median return three months after that signal was at an attractive 7.6%.

What’s more, if you look at how many S&P 500 stocks are trading above their own 200-day simple moving averages. That measure clocked in at under 20% in late September, a low seen only 15 times since 1998. And when you average out the returns seen three months after each of those occasions, you get a healthy 4.6%.

And lastly, leading indicators of risk-on market behavior are looking good, with high-yield bonds, the smaller-cap Russell 2000 stock index, and bitcoin all trading higher.

4. Fundamentals: what the broader picture tells you.

On the economics side, we’re in a regime of bad news = good news. When economic data is weak, it increases investor expectations that the Federal Reserve (the Fed) might pause in its aggressive rate-hiking campaign, a move that would be seen as a positive for stocks. The indicators have been mixed. The job market and economic growth have suggested signs of strength, but more forward-looking metrics like the purchasing managers index have suggested underlying weakness.

On the corporate side, it’s earnings season. And although companies seem to have held up pretty well so far, the large cap tech stocks (with the exception of Apple) have seen their share prices getting absolutely mauled. Nonetheless, the S&P 500 has been resilient overall, closing higher last week for its second week in a row. And that should give you further confidence in the likelihood of a bullish move.

5. The Fed pivot: what’s next for interest rates.

The most important thing that will drive markets for the rest of this year is Fed expectations. And lately, those have begun to shift. Increasingly, the expectation is that after the recent string of “hawkish” 0.75 percentage point rate hikes, the US central bank might become more “dovish”, pull back a bit, stop raising interest rates, and eventually even move to cut them. Several things are driving the more dovish outlook: a Wall Street Journal article suggesting a shift among Fed officials, for one, and public comments from San Francisco Fed President Mary Daly, for another. What’s more, other central banks have started to pull back: the Bank of Canada announced a smaller-than-expected rise at its last meeting, and the European Central Bank struck a more dovish tone. Will the Fed be the last domino to fall?

Investors appear to be bracing for a slowdown in Fed rate hikes, and this has led to a dip lower in the key interest rate that equities are valued off – the US 10-year Treasury yield. This has helped to lift the S&P 500 index. Just last week, the three-month-to-ten-year yield curve inverted last week, a sign of worries among investors and something the Fed considers an important metric in evaluating whether they’re doing enough.

What could throw cold water on this bullish thesis?

Though the case is strong for a rise in the S&P 500, that doesn’t mean it’s a done deal. At least three things could upend a future rally. So you’ll want to watch for these risks. First is a major escalation in the ongoing conflict between Russia and Ukraine, potentially one involving the use of nuclear weapons: it would likely prompt a selloff in stocks and a new surge in energy prices. Second is a push higher in Treasury yields and rate expectations, perhaps stemming from the Fed’s statement later this week or from a key inflation report due out next week. Third is a break below the closely watched 3,550 support level for the S&P, and a revisit of the October 14th lows of 3,490. Any one of these factors could rattle a stock investor’s resolve and keep them from buying.

So what’s the opportunity?

If you think the S&P 500 is likely to rise even higher into year-end, you could buy the iShares Core S&P 500 ETF (ticker: IVV; expense ratio: 0.03%) or via your broker on margin. You could look to target a rise toward the 4,000-4,150 range, which is where the 200-day simple moving average and range resistance sit.

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Disclaimer: These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment advisor.

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