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S&P 500 index February forecast: the uptrend is likely to continue

By David Becker

Positive liquidity provided by central banks should continue to lift the S&P 500 index

The large-cap benchmark US S&P 500 index is up nearly 3 per cent for January. There is a saying, “as goes January, so goes the rest of the year”. The saying means that historically when returns on the S&P 500 index are positive in January then the annual returns are generally positive. Additionally, the reverse is also true. The seasonality of the market generally also points to positive returns in February for the large-cap index.

The Fed will likely keep rates unchanged and economic growth should remain mixed, which may keep the Fed on the sidelines for the foreseeable future. The fly in the ointment is the coronavirus which is spreading across China and has made its way to the United States. During the SARs virus which hit Asia in 2003, global equity markets initially dipped before surging to new highs. Earnings season has started which could provide another impetus for a further uptrend in the S&P 500 index.

The Chinese coronavirus could weigh on future growth prospects

Chinese authorities have increased their virus containment strategy. They have cut off travel for more than 30 million people. Eventually, if this continues, the containment will be a drag on growth. For example, in 2003 the Chinese GDP fell by around two percentage points because of SARS. The virus may hit services harder than manufacturing. It will also add to the typical distortion of the data that is reported for January in February.

S&P 500 predictions: seasonality of the index

February has been a good month for stocks during the past decade. Over the past 10 years, the S&P 500 index was higher 80 per cent of the time, with an average gain during February of 2.3 per cent. That is the highest average return on the large-cap index, seen during the past decade. April, July and November have also seen robust returns that are positive more than 80 per cent of the time during the past 10-years.

What has led the index higher?

The solid returns the markets experienced in January were driven by technology shares which are up 5.5 per cent as we head into February. Utilities also outperformed rising nearly 5 per cent, which shows that investors are also playing defence and believe that rates will continue to remain steady or move lower. Generally, they outperform when investors are looking for yields. Utilities are generally considered an alternative to treasuries when yields are falling.

The worst performing sector in the S&P 500 index in January has been energy shares. Energy has been dragged down by declines in both oil and natural gas prices. Huge production and steady demand have weighed on natural gas prices. Oil prices have felt headwinds due to the coronavirus outbreak and elevated inventory levels.

A wave of liquidity

Central banks from around the globe continue to provide liquidity. This includes purchasing bonds, as well as asset-backed securities. The Fed continues to increase its portfolio, along with the European Central Bank, the Bank of Japan and the Bank of England. With central banks continuing to provide substantial liquidity keeping yields in Europe and Asia below zero, investors have little choice but to buy riskier assets such as stocks.

Are stocks valued correctly?

Earnings growth appears to be coming in less than expected, but the large-cap tech shares that have been the growth drivers have yet to report earnings. The forward price to earnings (PE) ratio which gauges the multiple that investors are paying for future earnings is approximately 19. This compares to a historical forward PE ratio of 16.7. Earnings growth for some of the large-cap tech names such as Apple and Microsoft are expected to come in at 11 per cent, compared to an average earnings growth rate of 5 per cent.

S&P 500 technical analysis

The S&P 500 technical analysis shows the large-cap index is trending higher and likely to continue to move higher in February. Prices have been hovering near the 10-day moving average and barely sliding away from the average trend.

Prices are overbought. The relative strength index (RSI) which is a momentum index, is printing a reading of 72, above the overbought trigger level of 70, which could foreshadow a correction in prices. The fast stochastic, which is a momentum oscillator generating a crossover sell signal in overbought territory, which points to a potential correction. The current reading of 92, is above the overbought trigger level of 80 which also could foreshadow a correction.

Medium-term momentum is neutral as the MACD (moving average convergence divergence) histogram is printing in the black with a flat trajectory which points to consolidation.

Volatility remains subdued

The VIX volatility index remains depressed which shows complacency. The markets are not pricing in an adverse market change. The volatility index is trading near 13, above the recent lows below 21, and well below the six-month highs near 25. This low level of implied volatility shows that traders would be surprised with an adverse change in prices which might lead to a swift sharp selloff.

Looking forward

February may be another positive month for stocks, as the uptrend is likely to continue. The new wall of worry is the coronavirus, which might lead investors to believe that global growth will slow. Earnings need to be impressive, to keep sentiment buoyed.

Fortunately, for stock bulls, easy-money will remain available as central banks continue to provide liquidity. This means there is little alternative to stocks, which will keep equity prices elevated. The seasonals also point to a positive February. Traders should keep an eye on the best performing sector. If technology begins to retrace, look for a pullback in the S&P 500 index in February.

FURTHER READING: What is the coronavirus and how could it affect stock markets?

FURTHER READING: S&P 500 forecast for 2020

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