What’s Driving Equity Values?

by George Hatjoullis

A very interesting tool for market analysis, Quant Insight, has thrown up some interesting sensitivities (I must declare an interest being an, albeit very small, shareholder). It seems that bad news is, once again, bad news, at least in the US equity market. Weaker growth will hurt equities, and in particular the S&P 500, according to this tool. Somewhat less surprising, but no less interesting, the S&P 500 is highly sensitive to credit spreads. Lower credit spreads boost the S&P 500. Finally, also somewhat less surprising, the S&P 500 is highly sensitive to real interest rates. Lower real interest rates boost the S&P 500. Hold these thoughts.

Elsewhere I am informed that the proportion of stocks driving this recent rally is historically small. This is not, it seems a broad-based rally. David Keohane of FT Alphaville reports today that Andrew Lapthorne of SocGen fame expects the rally to fade once the reporting season (or as Andrew styles it, the cheating season) is over. His thesis is that the guidance from corporations is designed to bias results to positive surprises (who would have guessed?). The rally seen in October does seem to have been driven by a substantial short base. It has been technical in so many ways. Taken together this collection of observations points to at the very least a correction between now and year-end. However, this is not all.

On December 16, the Federal Reserve will decide upon interest rates once again. It may initiate a small but thoroughly qualified increase. If as one suspects, the data between now and year-end (and into the New Year for that matter) are softer than hitherto, then such a hike may be deemed, at least initially, a policy error. A rate hike in the absence of a jump in inflation will raise ex post real interest rates. It is likely to rattle credit markets and push up credit spreads. Softer data without the offset of positive earning surprises could start to weigh on equities.

Of course, all this is quite speculative. The data may be strong, but I doubt it. The Federal Reserve may wait until the New Year to hike, but I doubt it. In any event it is a long time until December 16. Some shorts must have covered. It is year-end and no one wants to go into the party season worrying about investments. If nervousness and caution creep in we may see some adjustment to positions. It may be that we have seen the best of the S&P 500 for this year. Finally, a monthly chart of the S&P 500 offers some basis for imagination. Is it another month of gains and new highs or another big down candle? The RSI would suggest the latter.

S&P 500 Monthly

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