Why S&P 500 Stocks May Rebound 6% Short Term

(Note: The author of this fundamental analysis is a financial writer and portfolio manager.)

The S&P 500 (SPY) may be on the verge of breaking out, resulting in a rise of over 6% over the near term, from its current level around 2,640. The S&P 500 is down nearly 1.5% on the year, but it is down almost 8.5% from its highs seen in late January. 

It is not only the technicals that are set up nicely for the S&P 500, but earnings are also forecast to climb an additional 10.3% in 2019 to $170.03 per share, according to data provided by S&P Dow Jones Indices. That leaves the S&P 500 currently trading at only 15.5 times 2019 estimates. 

Strong Trends

The chart below shows a long-term uptrend that has been in place in the S&P 500 since February 2016. The index has tested that trend on a number of occasions over the past few months and, to this point, has held firm. Additionally, a clear downtrend has formed in the S&P 500 since peaking in late January. The two trends come together to create a symmetrical triangle, and that is a bullish  continuation pattern, suggesting the index is nearing a breakout over the short to medium term.  The breakout would occur once the S&P rose above the downtrend, and would trigger a rise toward the next level of resistance level around 2,800, about 6.5% higher from the S&P 500's current level. Additionally, should the index increase above 2,800, it could be on a path to travel even higher, on toward 3,000 over the next year.

Improving Relative Strength

Over the last several years, the relative strength index (RSI) on the S&P 500 has only hit oversold levels on a few occasions. Since the start of 2018, the RSI has hit 30 twice, and the last time it hit such low level was in November 2016, January 2016, August 2015 and October 2014, all of which proved to be market bottoms. Additionally, the RSI appears that it is starting to trend higher in recent weeks, another bullish indicator. 

Strong Earnings

If the positive technicals weren't enough, fundamentals in the overall market continue to be strong, with earnings set to soar not just in 2018 but into 2019 as well. According to S&P Dow Jones Indices, profits are forecast to climb by 10% in 2019, to $170.03 from $154.18. Additionally, the firm earnings growth leaves the S&P 500 trading at only 17.1 times 2018 earnings and 15.5 times 2019 earnings. Should the S&P 500 climb to 3,000 over the next year, as chart the suggests, the S&P 500 would be trading at—get this—17.6 times earnings, nearly identical to today's present valuation using 2018 estimates. 

Of course, it is entirely possible that earnings forecast are too high, and the market's lack of performance in 2018 serves as an indication that earnings estimates need to come down. But it could also mean that S&P 500 is currently cheap, and has a lot further to rise from current levels. 

Michael Kramer is the founder of Mott Capital Management LLC, a registered investment adviser, and the founder of the company's actively managed, long-only Thematic Growth Portfolio. Kramer typically buys and holds stocks for a duration of two to three years. Click here for Kramer's bio and his portfolio's holdings. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein.Upon request, the advisor will provide a list of all recommendation made during the past twelve months. Past performance is not indicative of future performance. 

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