by Dave Evans of binary.com
The party is coming to an end
After breaking through to record highs, the S&P 500 has been slipping back this week, falling to its lowest levels since mid-August. The prospect of an extended military action in Iraq and Syria is taking its toll, but it’s clear that the equity rally has been fragile since the turn of the month.
S&P 500 Daily Chart
A big driver of this activity is that looming storm cloud of Federal Reserve tightening its policies. This includes the twin threat of removing its Quantitative Easing activities and eventually increasing interest rates for the first time since June 2004.
S&P 500 Monthly Chart
While global economies haven’t exactly lit the torch paper, stock markets have reached for the skies. US Equities have ridden the tech bubble, the 2008 financial crisis and made the Eurozone problems seem like nothing more than an irritation.
US Interest rates since 2000
In the chart above, we can see how interest rate peaks have roughly coincided with peaks in the stock market in 2000 and 2007, but also how stark lack of interest rate increases has in part allowed stock markets to push to higher levels unencumbered.
However, times they are a changing
The fuels of this equity rally (QE and near zero rates) are about to be turned off and this can only be bad news for US equities. There is a general complacency amongst investors that the Fed will step in and save them in the event of a sustained bear market, but this is hardly a responsible investment strategy, especially when many market valuation metrics continue to point out that the market is running too hot. The cyclically adjusted 10 year PE ratio is currently 55% above its average, while the S&P 500 is 85% above its regression trend line (that’s higher than at the 2007 peak).
Timing a correction is never a precise science, but with markets showing increased signs of fragility, now is not a bad time to start placing those downside bets.
A good way to play this is a LOWER trade predicting that the S&P 500 will be lower than 1900 in 363 days time for a potential return of 170%. Or put another way, betting that the S&P 500 will close below 1900 on the 24th of September 2015 could return £27.03 from a £10 stake.
But dollar’s days are just beginning
While the S&P 500 could be set for a fall, or at least a pause, the US dollar could be poised for lift off. The dollar index has risen rapidly in the last three, but judging by the monthly chart below, we may only just be at the beginning of an extended rally for the Greenback.
Dollar Index Monthly Chart
The dollar has been in decline ever since the heady days of the tech boom. There have been some false dawns since the early 2008 bottom, but now we could finally see an extended turn around.
The chart above shows just how far the dollar has fallen and while the climb up may not be as rapid as the fall down, we could still see some impressive movement from here.
All of this could weigh heavily on the euro, which showed renewed weakness this week. An influential S&P report warned that the surge in popularity of the Alternative for Deutschland party “could lead to a reorganisation of Germany’s official response to the euro area economic crisis”. The European economy continues to stagnate and we could be as bold as to say that it will continue to do so until there is dramatic structural reform across the Eurozone.
Whether it’s the ECB’s eventual activation of its QE activities, or a continuation of the Eurozone’s weakness, the outcome is likely to be the same – Further weakness for the EUR/ USD.
A good way to play this is a LOWER trade predicting that the EUR/ USD predicting that it will close below 1.2100 in 363 days time for a potential return of 296%. Or put another way, betting that the EUR/ USD will close below 1.2100 at the close on September 24th 2015 could return £39.59 from a £10.00 stake.
Disclaimer: This financial market report is intended for educational and information purposes only. It should not be construed as investment or financial advice and you should not rely on any of its content to make or refrain from making any investment decisions. Binary.com accepts no liability whatsoever for any losses incurred by users in their trading. Fixed odds trading may incur losses as well as gains.