S&P 500: 3000 by 2020 ?

by George Hatjoullis

S&P 500

An article in today’s FT speaks of the S&P 500 rising to 3000 by 2020.This of the order of 50% in 6 years or a compound growth rate of 7% per annum. An unremarkable claim and quite plausible. The reason the author believes this is not the subject of the blog and you can read the FT article for yourself (http://on.ft.com/1z9EqXE). The interesting aspect is the appearance of the article. Bullish articles normally start to appear just before a significant reversal, so one wonders if this may be a sign.

The above chart is a monthly chart of the S&P 500 back to 1997. It is proof of the old adage that there is no such thing as a triple top. Moreover an extension of the present uptrend to 3000 looks entirely reasonable. Equity markets are classified as Submartingale stochastic processes which basically means they tend to move higher. However, although the trend bias is higher the actual path can involve reversals. The behavioural dynamics of reversals are quite complex but one recurring aspect is complacency. Articles such the one in the FT hint of complacency. The chart above is unfortunately not very clear but note the bottom chart. This is the Relative Strength Index or RSI. Traders use this as an indicator of a market being overbought and due a reversal. It is clear that the previous two reversals were preceded by an overbought market even from my little chart.

Another simple rule used by traders is the channel, which is faintly visible. Markets tend to oscillate in a channel even if strongly trending higher. The S&P 500 has been crawling along the top of a well-defined channel for some time. It could go sideways for an extended period and still be within this up channel. It could also drop to the bottom of the channel. This could take it as low as 1800. The combination of this channel and the RSI is one reason traders, whilst bullish, might be a little nervous of the immediate path. It may well go to 3000 by 2020 but it may visit 1800, or even lower, first.

The fundamental backdrop is also uncertain. When will the Federal Reserve raise interest rates? At what point does the strong US Dollar impact earnings? Will the US succumb to global deflation pressures? Oil and commodity prices are looking vulnerable even after large falls. This may be saying something about global demand conditions to which US equities are not immune. So what should the trader, and careful investor, that cannot live with a 10-15% drawdown or reversal do? Well, that is your problem. However, my reaction to such situations is to get cautious. If the market is telling me (via the charts) that caution is called for but the FT is telling me to keep my eye on the future, I become even more cautious. The FT and other newspapers have a very poor track record but the charts never lie.


Postscript 2/03/2017

This article was posted 4/02/2015. The S&P 500 visited the low 1800 level 3 times before resuming the most recent upward path in February 2016. The 3000 by 2020 target remains possible and indeed likely. Of course another dip before then is also likely. The moral of the story is if you like the destination and have time for detours stay on the bus. If you get off to see local sights you may miss the bus.