The U.S. stock market has been in a choppy sideways pattern ever since late January. Concerns over rising interest rates, political risks, and potential trade wars have competed with the investor bullishness from tax cuts and a strong economy to create mixed market conditions.
Represented by the SPDR S&P 500 ETF in the chart below, we can see that the S&P 500 (and the C Fund that tracks it) has so far remained above a key metric – its 200-day moving average (blue line):
While long-term investors focus more heavily on fundamentals (like earnings, balance sheets, valuations, and so forth), most stock trades these days are done by computer algorithms and short-term human traders. Many algorithms are programmed around technical trends, with the 200-day moving average being a particularly well-known one.
The 200-day moving average can be considered a line of mild resistance. It’s an important psychological level for both human traders and computer algorithms, and so as prices get close to it, there is some upward buying pressure. Especially for such a well-followed index like the S&P 500.
And so far, that line has held.
Earnings Season is Underway
Now that we’re in mid-April, companies are beginning to report earnings for the first three months of the year.
The consensus analyst estimate is that total S&P 500 earnings for this quarter will be 17% higher than they were for 2017. This is partly from growth, but corporate tax cuts and share buybacks are playing a leading role in this bottom-line growth. JP Morgan is more bullish, and expects earnings will be closer to 21% higher than last year’s numbers. Big banks in particular are expected to report earnings well over 20% higher than a year ago, due to both rising interest rates and tax cuts.
But as JP Morgan, Wells Fargo, and Citigroup all reported first quarter results late last week that beat analyst estimates, their stock prices declined. Citigroup’s stock price declined over 1.5% on Friday after earnings were announced, while JP Morgan declined over 2.5% and Wells Fargo declined nearly 3.5%.
That same day, PNC Financial Services, another huge bank, reported results roughly in line with estimates and its stock declined over 4%. Its effective tax rate was 17%, down from 24% last year.
This shows that investors are placing high expectations on this quarter’s earnings season. During this environment of high market valuations, investors are expecting earnings beats and major revenue and earnings gains to justify historically high stock prices.
The current price-to-earnings ratio for the S&P 500 is about 24x, which is above average. The financial sector is a bit cheaper, at 20-21x earnings on average, but this is still quite pricey.
Over the next couple weeks, more companies will report their earnings, which could result in substantial up-or-down swings for their stock prices like we’ve seen so far.