Is the S&P 500 nearing escape velocity?

Michael McKerr, 07/11/2019

Strategist, Institutional Trading Education, TD Ameritrade Institutional

Adam Smith first introduced the economic concept of the invisible hand in "The Wealth of Nations".

It's the unobservable market force that helps balance supply and demand. Many believe the U.S./China trade war has implicitly been the invisible hand driving markets since August 2017 when U.S. Trade Representative Lighthizer opened its formal investigation into alleged unfair trade practices by China. Ultimately, the Federal Reserve may have owned that role when we consider their speeches and policy decisions. Looking through the lens of technical analysis, one must wonder whether the S&P 500 is nearing escape velocity or if its engine is about to sputter.

The idea that the Fed's invisible hand has largely driven markets is strengthened when we look at Fed Chair Powell's speeches and decisions overlaid on a 2 year chart of the S&P 500 index (see below). While most may think the U.S./China tit for tat tariff spat caused the incredible volatility in Q4 2018, Powell's October 2^nd speech was likely the starter log for that fire. He stated that he believed interest rates were a long way below neutral, implying significantly more rate hikes ahead than priced by markets. The Winter Slaughter of 2018 thereby ensued.

Fed Chair Powell's speeches and decisions overlaid on a 2 year chart of the Standard and Poor 500 index

Source: thinkorswim. For illustrative purposes only

Fast forward to January 4^th when Powell said the Federal Reserve would be “patient" in its approach to monetary policy. Markets shot out of the gate like the 2018 Triple Crown winner Justify. In early May, Powell explained that persistently low inflation was likely due to transitory influences, which markets took as a sign that rate cuts were not as likely as thought. The S&P 500 fell 7% throughout the month of May. Nearly 6 weeks later at the June FOMC meeting, the Fed removed 'patience' from its policy statement, and the S&P 500 continued its ascent, compounded by apparent progress on a U.S./China trade deal. Most recently, Powell's semiannual monetary policy report to Congress this week pushed the S&P 500 to the psychological 3,000 level as he signaled the Fed's worry over trade uncertainties and business investment. That said, a number of technical analysis studies may suggest the S&P 500 is either nearing an intermediate top or preparing for the next leg higher.

Applying a linear regression analysis to the S&P 500 over the last 10 years helps us visualize price trends in the index. Coincidence or not, many of the tops and bottoms throughout the course of this aging bull market have coincided with support and resistance levels on this linear regression (see below). As the S&P 500 approaches the psychological 3,000 level, it's also nearing a confluence of resistance at not only the 50% upper band of the regression but also the trend line top connecting the prior market peaks in 2018. Click here for chart.

A chart showing linear regression analysis applied to the Standard and Poor 500 over the last 10 years

Source: thinkorswim. For illustrative purposes only

While the aforementioned resistance may end up capping the S&P500's ascent, a massive inverse Head & Shoulders pattern has formed after the last year's unsettling volatility (click here for chart below). Earlier this year, we highlighted a similar pattern in crude oil, which ultimately validated and led to a 20% rally. Revisiting that article would help understand the dynamics of the pattern. That said, the S&P500 has popped above the inverted neckline resistance, so the pattern is nearing validation. If validated, it could put upside targets on the S&P500 near 3,325 and 3,550, which represents 61% and 100% of the head to neckline distance. Ultimately, this could be the escape velocity moment where the market separates itself from the forces of gravity, much like a NASA space shuttle as it exits the Earth's atmosphere.

A chart showing a massive inverse Head and Shoulders pattern that formed after last year's unsettling volatility

Source: thinkorswim. For illustrative purposes only

Looking at the past 18-24 months, the Fed's impact on the market has been significant. A slip of the tongue or added word to the policy statement has contributed to billions of market cap added and subtracted from global markets. Their not-so-invisible hand has helped guide both the economy and equity markets. While the S&P500 is coming to a potentially major breakout level, the linear regression analysis shows the 3,000 – 3,025 to be significant resistance, yet as the Fed signals it is prepared to lower interest rates in order to sustain the expansion, it may be just the fuel needed to push the S&P500 into escape velocity.

You cannot invest directly in an index.

Commentary provided for educational purposes only. Past performance of a security, strategy, or index is no guarantee of future results or investment success.

While these principals are the foundation of technical analysis, other approaches, including fundamental analysis, may assert very different views.