Is the Stock Market Rally Sustainable?

Technically the SP500:

• Breached the downtrend line and moved above the 100 Day moving average for the first time since October
• VIX at a new low since early October
• Market breadth is remarkably strong with the Advance-Decline line nearly back at the August all-time high
• Retail traders are still heavily short, indicating there may be further upside over the short-term

The SP500 now retraced over 61.8% of the September-December downmove, making a return to the September all time high more probable than a re-test of the December low, but it won’t be without hurdles. Next resistance within reach is the 200D MA at 2740, and more importantly the 2815 level on which the index failed three times b/w October & December. The latter is probably the last line in the sand for the “Bears”.

Is the rally sustainable?

Last year’s downturn left some psychological damage that will need to be overcome for a sustainable bull trend into new record highs to materialize, which won’t be an easy affair.

What has changed since December?

• Fed turned dovish: 2 or 3 expected hikes to zero, and balance sheet reduction from autopilot (50B /month) to flexible
• Dollar stabilized, which is easing pressure on emerging markets
• ECB not expected to hike before 2020

What has not changed?

• Europe still a drag: no signs of quick recovery: Jan PMIs remain weak especially in the largest economies of Germany, Italy and France. Weak foreign trade has yet to turnaround.
• China data mixed, despite stimulus measures
• China/US trade dispute unresolved
• Disagreement over the shutdown still unresolved

Stocks were just too cheap to ignore, and the Fed also gave it a nice push. Yet, valuations will soon no longer look cheap (SP500 1 year fwd PE is currently at 16x vs the 5 year average around 17x), and a dovish Fed should be close to priced in.

For a sustainable rally, companies will need to count on further earnings and revenue growth. On one side there are reasons to be optimistic with easier money and a more stable dollar, which should support Emerging Markets, and in turn help China and Europe. The US macro also looks more robust than feared, as illustrated by the latest job numbers. Going forward, the macro will be scrutinized by investors for confirmation.

On the other hand, Q4 earnings globally under-delivered compared with the previous three quarters of the year with much lower ratio of beats/misses and an important number of downward revisions for 2019 especially in the Technology and Energy sectors. Investors will be a lot less forgiving, when stocks are no longer cheap. While fears of recession were clearly overblown, weaker earnings confirms growth is slowing and the late cycle stage we are in.

Additionally, international trade now becomes the single biggest threat to global growth. The longer it drags, the more it will weight on company earnings going forward. How the US/Chinese trade negotiations evolve will greatly impact where equities go next.

The probability to move back to the September highs has greatly increased, however, investors need to be careful not to get too complacent too quickly, as volatility may be around the corner. Whether we return into a steady bull trend is probably too early to call.