S&P 500: Strong Long-Term Prospects Despite Short-Term Risks

The recent discussion of monetary policy by the Federal Reserve (Fed) during the current financial situation has profoundly impacted the stock market. While inflation is decreasing, the prospect of lower interest rates in September has created market uncertainty. Additionally, financial markets show declines in bank reserves, highlighting the risk of liquidity contraction in the system.

Despite these concerns, the S&P 500 remains within a strong uptrend, though short-term uncertainty suggests a potential price correction. This article presents the technical picture of the S&P 500 index and provides insights into the index’s next direction and investment opportunities for investors. It is found that the index is heading higher, but a short-term correction may offer a strong buying opportunity.

Inflation Trends and Liquidity Concerns in the S&P 500 Market

The recent dovish comments from Federal Reserve Chair Jerome Powell, emphasizing confidence in achieving the Fed’s inflation targets, have significant implications for the S&P 500. Powell’s remarks suggest that the central bank may soon pivot towards lowering interest rates. Such a monetary policy shift can reduce borrowing costs, stimulate economic activity, and potentially boost corporate earnings, which are critical stock price drivers. However, the allure of lower yields may shift the focus of some investors towards precious metals, which could slightly affect the inflow of capital into the S&P 500.

Despite Powell’s optimistic outlook on inflation, the Consumer Price Index (CPI) data in the chart below shows a complex picture. While there has been a noticeable decline in CPI values, suggesting that inflation pressures are easing, sticky consumer prices remain stable. This stability in sticky prices, which tend to be less volatile, provides a measure of predictability and suggests that inflation is becoming more manageable. However, the persistent drop in CPI values creates an environment of uncertainty for the S&P 500 in the short term. Investors weigh the potential benefits of an easing inflationary environment against the risks of an economic slowdown.

Moreover, financial market indicators point towards potential liquidity challenges ahead. The sharp decline in bank reserves at the Fed, approaching critical thresholds, signals a possible liquidity contraction. This could lead to a correction in both stock and bond markets, impacting the S&P 500. A rebound above $3455 billion is required to erase the system’s liquidity contraction risk.

On the other hand, the Chicago Fed Financial Conditions Index, currently at -0.529, shows strong liquidity, as shown in the chart below. Investors will closely monitor these indicators to gauge the liquidity in the system. A reversal in this indicator could warn of liquidity contraction in the system and increased uncertainty for the S&P 500.

Therefore, while the current economic indicators provide a mixed outlook, the potential for shifting monetary policies adds a layer of complexity for investors. Careful monitoring of liquidity conditions and inflation trends will be crucial for navigating the future movements of the S&P 500.

Factors Behind S&P 500’s Sustained Growth Since 2009

The long-term technical outlook for the S&P 500 is strongly bullish, as seen in the monthly chart below. It is observed that the S&P 500 bottomed in March 2009, marking a low at 666.79. After hitting this low, the index quickly reversed higher and consolidated to confirm a long-term bottom. This long-term bottom is viewed as an inverted head and shoulders pattern, with the head at 666.79 and the shoulders at 1270.05 and 1266.74, respectively.

This bottom in 2009 emerged as the strong base for the historical rallies, and the index is likely to remain at elevated levels. The bottom was formed due to aggressive monetary policy, fiscal stimulus, and structural economic recovery. In response to the 2008 financial crisis, the Fed implemented unprecedented measures such as lowering interest rates to near zero and introducing quantitative easing (QE) programs to inject liquidity into the economic system.

These actions stabilized the banking sector, restored investor confidence, and encouraged borrowing and investment. Concurrently, significant fiscal stimulus through government spending and tax incentives helped to stimulate economic growth and reduce unemployment. These policies laid the foundation for prolonged economic expansion, corporate profitability, and stock market gains, leading to a robust bull market that propelled the S&P 500 after 2009.

The strong rally after 2009 formed an ascending broadening wedge from 2015 to 2024. The index has been trading within this wedge for over a decade and forming bullish price action across multiple time frames. This bullish price action was observed through a reverse symmetrical triangle from 2018 to 2020 and an inverted head and shoulders pattern in 2022 and 2023.

The strong rally was observed from the symmetrical triangle formation in 2020 due to unprecedented monetary and fiscal policy responses to the COVID-19 pandemic, which stabilized financial markets and fueled economic recovery. The Fed implemented aggressive measures, including slashing interest rates to near zero, which increased liquidity and reduced borrowing costs. Concurrently, the U.S. government enacted substantial fiscal stimulus packages, including direct payments to individuals, enhanced unemployment benefits, and business support, bolstering consumer spending and corporate earnings.

Additionally, the rapid development and distribution of COVID-19 vaccines boosted investor confidence by promising a return to regular economic activity. These combined factors created a favourable environment for equities, driving the S&P 500 to record highs during this period. After the peak of this rally, the consolidation of 2022 and 2023 resulted in an inverted head and shoulder. The breakout of this pattern initiated another strong price surge towards the price target, which lay above 6,000 levels.

Overall, the technical picture of the S&P 500 remains bullish, and based on the historical technical bullish formations, it has set the stage for solid rallies in the coming years. These rallies are expected to occur after substantial price corrections towards support levels, which investors see as buying signals.

Short-Term Outlook & Key Action for Investors

As per the above discussion, the long-term outlook for the S&P 500 is strongly bullish, with prices poised to rise significantly. However, short-term indicators point to the risk of a price correction. This aligns with the possibility of liquidity contraction, as discussed in the first section of this article. The weekly chart below shows a rounding bottom formation, with a low at 3491.58 and a breakout of the neckline at 4600, which has initiated a surge in the index to record levels.

Major technology stocks such as Nvidia (NVDA), Microsoft (MSFT), and Apple (AAPL) have reached record highs during this rally of S&P 500. However, the S&P index indicates a need for correction before the next upward surge. This is also supported by the fact that major stocks are approaching their respective targets. Moreover, the RSI reading on the weekly chart below shows that technical indicators are poised for overbought conditions and suggest a need for a price correction.

This is further supported by the short-term daily chart below, which highlights a triangle formation and indicates that prices are contracting towards the triangle’s apex. This is the same phenomenon observed in the weekly chart. Interestingly, the RSI indicator also shows an overbought condition on the daily chart. A break below this triangle will indicate that the index has initiated a correction. This might occur if the Chicago Fed Financial Conditions Index recovers from its current levels, as discussed in the first section.

This price action is a strong indication for long-term investors to monitor these technical formations closely as the price corrects lower by breaking the triangle. A price correction will offer a strong buying opportunity for long-term and medium-term investors. The strong support lies around 45,000-$50,000.

Bottom Line

In conclusion, the S&P 500 is poised for a bullish long-term outlook driven by favourable monetary policies and historical technical patterns. The short-term trends need careful monitoring by investors. The interplay between declining CPI values, stable sticky consumer prices, and fluctuating liquidity conditions presents the complexity of the current market environment. Investors should remain vigilant, balancing the potential for significant gains with the inherent risks and view any price corrections as strategic buying opportunities for long-term and medium-term investments.