Investors feared adverse effects on the global recovery after the coronavirus situation escalated in Europe once again. Consequently, European equities posted their worst performance in three months and dragged the US market lower. Nonetheless, the situation led to an opportunity to buy the dip just as positive seasonality arrives.
The Upside Trend Is Intact
The S&P 500 remains overvalued and the Nasdaq 100 even shows typical bubble characteristics. We have elaborated on different valuation metrics and liquidity flows in the past few write-ups. These pointed to expensive valuations and highly speculative investor behavior, which are likely to bumper the market long-term. Nonetheless, we have also stressed that technicals were intact and likely to feed the rally until the short-term trend ends. That probably remains valid today as the market approaches a decisive junction. So far, the upside trend has remained technically intact.
Buying demand was strong into the early September all-time high before equities dropped without any attributable catalyst. The subsequent recovery unfolded a bullish impulse off the late September low. It has been halted by Europe’s most recent events, which led the Nasdaq 100 index back towards the pale grey trend channel. Technical analysts describe the most recent action as a retest after the tech index broke out. A successful retest would result in an upside continuation. Such a bullish scenario is likely if 3150 (S&P 500) and 10700 (Nasdaq 100) don’t break down sustainably.
Seasonality Brings Tailwind
Seasonality factors support a rally for the remainder of the year. Goldman Sachs summarized average periodic returns in the chart below. It shows that the last two months of the year have been particularly strong during the past decades. News flow is likely to be supportive as well during the next few weeks. We will hear about the US Presidential election and China’s economic plan foremost. Both events are unlikely to surprise to the downside.
The remainder of the year will probably focus on the coronavirus pandemic. Most likely, it will swing back and forth between lockdown concerns and vaccine hopes. Again, both catalysts are likely to surprise on the upside. The Good Judgment Project (GJP) assesses a probability of close to 95% that 25 million US people can get inoculated until the end of Q3/2021. The GJP estimates are from forecasting experts with a statistically significant track record. The individuals proved to be consistently more accurate than the general public or experts. Hence, a vaccine is very likely coming during the next few months. Additional lockdown measures are likely as well as the Winter approaches. However, there is little doubt that our policymakers pass these along with additional stimulus measures. Western economies have been on a spending spree. There is no evidence that the expansionary trend ended already despite being on a head-on collision course.
An Asymmetric Risk/Reward Short-Term
The bottom line is that technicals proved correct in the past months. The short-term trend remains most likely intact unless 3150 in the S&P 500 and 10700 in the Nasdaq 100 break down sustainably. Seasonality is likely to carry US equities roughly 20% higher towards the next major overhead resistances. This translates into a bullish short-term setup with an asymmetric risk/reward profile. Nonetheless, the bigger picture is unchanged. The US equity market is overvalued and will most likely disappoint investors during the next decade. Therefore, long-term investors or those who cannot have a close eye on the market remain best off on the sidelines.