Equity markets – a buy signal or a trap for the bulls?

The fourth quarter on the US equity markets was so good that it took only moderate advances at the beginning of this year to bring the S&P500 futures to the key resistance at ca. 1290 pts. This level is important because in combination with a mid-term trend line (drawn along the local lows) it makes a triangle formation. Moving out of this formation would in theory herald a rally possibly to ’11 highs around 1370 pts.

Now while it sounds like a very bullish outlook, probably too bullish and here is the problem. Moving to ’11 highs could be a sign of too high optimism for two reasons. Firstly, we still face serious risks in Europe: a successful auction of Spanish bonds yesterday is only a small step of a giant refinancing that governments face in a February-April period. Rating agencies may complicate this process as they need to complete their assessment of all euro zone countries and it is very likely that at least some will face a rate cut. Germany seems to be safe but a cut to France could seriously undermine confidence on the market. Secondly, despite the decent data from the US economy thus far, growth prospects moderated noticeably, even in the US. While banking sector does not face such pressures as in Europe (and thus a credit action will not be so much contained), high oil prices hurt consumer confidence. The data released yesterday showed that the annual retail sales dynamics was the lowest since August’10, despite much higher inflation (retail sales is reported in nominal terms).

Therefore those short term advances might pose a trap for the bulls, especially if rating agencies move back to the front of the picture. Technically, a close of the week should provide some indication. A close above 1290 pts. could encourage more buyers next week and trigger at least a short-term rally. A retreat below that level today would leave us within a triangle and would offer bears a chance to bring the index futures back to the trend line (currently ca. 1290 points).

Przemysław Kwiecień PhD, Chief Economist

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