After experiencing the hot year of 2023, the US stock market's upward trend in the new year has encountered some resistance. The S&P 500 index has repeatedly hit historic highs without success, and the warming situation in the Red Sea region has disrupted safe haven sentiment. The performance of Apple's downgrade has shown the fragile side of heavyweight stocks to the outside world. Many institutions have issued warnings about potential adjustment risks, believing that interest rate expectations, slowing seasonal capital inflows, and poor performance in the financial reporting season will all become bearish factors.
Risk adjustment is still brewing
Technical indicators are the risk of market sentiment fluctuations in the eyes of market professionals. Taking the S&P 500 index as an example, according to FactSet data, its 14 day relative strength index (RSI) broke through 80 at the end of last year, reaching its highest point since 2020, causing a volatile trend in the past two weeks. Since the beginning of this week, the indicator has shown a dead cross after being passivated at a high level, indicating that selling pressure may continue.
Boris Schlossberg, macro strategist at BK asset management, stated in an interview with First Financial that after a new round of gains at the end of last year, the market has accumulated a lot of profit chips. Therefore, when unfavorable external factors impact the original upward logic, profit taking is a very normal situation.
In fact, from the dimensions of market sentiment and breadth, the index is indeed under a lot of pressure.
According to the weekly sentiment survey by the American Association of Individual Investors (AAII), in just two months since late October last year, investors have shifted their stance from extreme bearish to extreme bullish. As of last week, nearly 48% of respondents remained optimistic, at the highest level in nearly two years. It should be noted that historically, this indicator can be considered a reliable reverse indicator.
Short positions in the derivatives market are beginning to gain momentum. According to institutional statistics, the proportion of put options in US stocks has rebounded for two consecutive weeks since hitting a low point at the end of last year, which is also an important pressure signal. The expansion of market breadth has begun to reverse. According to a summary by First Financial reporters, the proportion of stocks listed on the three major exchanges in the United States that stand above the 50 day moving average on the short-term strength boundary has decreased from 81% at the end of last year to 60%, and the proportion of stocks above the 200 day moving average on the medium - and long-term strength boundary has also fallen back to 62%. The number of stocks that set a new low of 52 weeks is slowly increasing and approaching the new high of 52 weeks.
Insufficient incremental funds can be quite tricky. Schr ö sberg told First Financial that generally speaking, after the end of the Christmas holiday, many institutions will choose to enter the market to build or increase positions within the two weeks before the New Year. Subsequently, funds will enter a wait-and-see period, waiting for the latest clues on economic data or monetary policy, resulting in insufficient market momentum. From the current situation, in addition to performance, investors have shifted their focus to the game of interest rate cuts.
Alastair Pinder, global equity strategist at HSBC, stated in a report that the US stock market has surpassed fundamentals and a pullback seems to be occurring to a large extent. "As the market's expectations for interest rate pricing increase, the attractiveness of risk/return seems to decrease." Senior strategist David Rosenberg believes that the situation in 2024 looks surprisingly similar to that in 2022, with positioning, sentiment, and technical indicators at extreme levels that match the situation seen in December 2021 (even worse fundamentals).
The financial report season test cannot be ignored
The new earnings season for the US stock market began last week. First Financial previously reported that due to the slowdown in commercial activities, institutions have significantly lowered their performance expectations for listed companies in the fourth quarter of last year in the past three months.
As an economic barometer, the financial reports of financial institutions did not start off well. Following Citigroup, Bank of America, and JPMorgan Chase, Morgan Stanley also reported a decline in profits this week. Although interest rate spreads continue to push up net interest income, some banks have seen an increase in loan loss provisions under high interest rates. At the same time, the banking industry also needs to face the requirement of increasing capital, which is part of the new Basel Accord regulations proposed by the US banking regulatory authorities.
James Fotheringham, BMO analyst at Bank of Montreal, warned in his report that even if the United States avoids a recession in 2024, the industry will still face challenges and resistance. "Now it seems that the banking industry is easily affected by the upcoming credit cycle and increasingly high capital requirements (seemingly endless regulatory pressure)."
According to FactSet's statistics on institutions, analysts predict that the profits of S&P 500 index constituent stocks will increase by 11.7% year-on-year in 2024. As the US economy further slows down in the first half of the year, investors are now facing the challenge of whether companies can achieve this goal. According to data provided by LSEG on the London Stock Exchange to First Financial, the 12 month forward P/E ratio of the S&P 500 index has reached 19.5 times, far higher than the historical average of 15 times.
Jean Boivin, director of BlackRock Investment Research, wrote that the new financial reporting season of 2023 (Q4) should provide more insight into how growth expectations will evolve. "Due to the pressure of rising interest rates, sustained wage increases, and a decrease in inflation rates (still above target), profit margins will continue to normalize over time."
D. James Ragan, Director of Wealth Management Research at Davidson, said, "We do not expect the P/E ratio to continue to expand significantly from now on, as valuations are a bit tight and will depend on the sustainability sources of earnings growth." He believes that the fair value of the S&P 500 index is 4700 points, roughly equivalent to current trading levels.