S&P 500; a change in narrative

by George Hatjoullis

The S&P 500 may finally have run out of steam (famous last words). To be fair this blog has been unrelenting in its bullishness until today and is not about to get seriously bearish. The two elements that have caused the cautious instincts to trigger are non-farm payrolls and Ukraine. Non-farm payrolls are signalling a robust US economy, so robust that the Federal reserve might reasonably be expected to bring forward its guidance. The single reservation is the US CPI. However, even this has stabilised. The S&P 500 is a good leading indicator of US economic activity. It signalled recovery long before any economist seemed convinced. It is now signalling strong growth and this is supported by regular payroll growth. The next concern will be rising interest rates.

If it was only the economy then the S&P 500 might grind up even from here for a while longer. However, geopolitics has added an unexpected element, namely Ukraine. It is difficult to see a painless outcome arising. Russia has de facto annexed Crimea and very soon the annexation may be formalised. It is of little market relevance who is in the right so it is best not to let this get in the way of market logic. Everybody has talked themselves into intransigent positions. Diplomacy has failed because there are no obvious face saving routes and no one seems inclined to back down. Ukraine is determined to retain its integrity, spurred on by righteous indignation from the West. Russia feels aggrieved and threatened and will almost certainly hang on to Crimea by force if necessary. Indeed Russia may yet extend the annexation further along its eastern frontier with Ukraine. The West may be forced to match righteous indignation with force or leave Ukraine hanging. Sanctions will not affect this situation. The prospect of a shooting war between Russia and the West is not something anyone is seriously considering (in my view) but the logic of the current direction ends there. The S&P 500 may not survive such a development without a wobble.

The other market implication is for the US dollar. It is technically ready to rally and a shooting war will give it a almighty boost. Holding euro in this situation suggests a lack of grasp of logistics. The gold price, swiss franc and Yen may also benefit depending upon positions. However, Japan has other problems and a strengthening Yen is not consistent with resolving these problems. It should always be borne in mind that Japan can do with the Yen what Switzerland has done with the franc. It would be entirely consistent with the monetary policy target. So in a nutshell, lighten up on S&P 500, buy Dollars and canned food.