Is a Wave Of Momentum Building for the S&P?

Is a Wave Of Momentum Building for the S&P?

Fourth quarter of last year brought a fierce rally to the S&P. What are the chances that can happen again this year?

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As trading opened late Sunday night, international markets were moved by the announcement of a new trade agreement between the United States and Canada.

Bullish momentum continued to build, and on Monday morning, the S&P 500 opened higher on the positive vibes of a new trade deal. The market digested the good news and it fed another push higher to start a week.

With today being the first day of the fourth quarter, should we take the events of this morning as a sign of what is to come as we close out the year?

 

Last years Stock Market Rally

 

Last year, the S&P began a steep ascent up that would last through the fourth quarter and into 2018 as the market 'melted up' to record highs.

Between the first trading session of August and the end of the year, the index moved over 8% during a historic end of year rally.

 

chart built by Jason Pfaff

 

There seems to be additional headwinds in place this year that were not in place last year. China and the US are at odds over trade policy, and the danger of additional tarrifs loom for markets. Interest rates are rising as the Federal Reserve is determined to tighten monetary policy. And there is uncertainty roiling Europe as the twin dramas of Brexit and Italian debt unfold.

On the other hand, what fueled the rally last time seems to be firmly entrenched yet again and that is a deep sense of optimism that the market can shrug off challenges and power higher via the strength of the American consumer of expanding corporate profits.

Further opening up the environment for a potential move higher in the S&P is the VIX, the volatility index, which continues to move lower.

Volatility is a measure of the level of disagreement in a market, and the lower the level of disagreement in a rising market, the more bullish the sentiment can be.

 

chart built by Jason Pfaff

 

We can also see momentum building as moving average indicators widening as the index moves up.

One key indicator we track, and a simple guage of momentum, is the divergence between the 200 day moving average and the price of the index.

A widening divergence signals growing momentum. If the momentum is building, and volatility remains low, the market could have significant energy to move higher.

On the other hand, we all know at some point markets correct. As solid as the current bull market seems, all indices move lower at some point in time. 

Lately, the greatest risk seems to be from overextension, meaning the market moves too far too fast and is forced to realign back to more reasonable valuations.

When looking over the past few years, a divergence between price and the 200 day moving average of over 8% seems to be the point where the market begins to signal it is possibly overextended.

A divergence between 6-8% seems to be a zone of accelerating momentum.

We just recently crossed over 6%, which tells us compared to historicals we might have additional runway to the upside before being overextended and seeing a correction.

 

chart built by Jason Pfaff

 

In short, the mix we are currently seeing; momentum, positive sentiment, earnings growth and low volatility could fuel the wave further.

However, we also know, all waves crest at some point, and break and roll back out to sea. While that still point still seems to be off in the distance, watching volatlity and the divergence between the moving averages can tell us how far off it might be.

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