S&P 500; US Indexes Fundamental Weekly Forecast – Momentum Shift Could Lead to Volatile Correction

The major U.S. stock indexes started 2018 on a positive note, with all three equity indexes reaching record highs. The highlights of the week were the Dow overtaking the psychological 25,000 level for the first time. The S&P 500 Index posted its best weekly performance in over a year. Global equity markets also continued their 2017 run with strong rallies last week.

In the cash market for the week, the benchmark S&P 500 Index settled at 2743.15, up 2.6%. The blue chip Dow Jones Industrial Average finished at 25,295.87, up 2.3% and the tech-based NASDAQ Composite closed at 7134.24, up 3.4%.

March futures contracts also posted solid gains for the week. The March E-mini S&P 500 Index settled at 2742.50, up 66.50 or +2.49%. The March E-mini Dow Jones Industrial Average finished at 25269, up 534 or +2.16% and the March E-mini NASDAQ-100 Index closed at 6667.75, up 259.00 or +4.04%.

The U.S. also released a slew of economic data last week.

On January 3, ISM Manufacturing PMI beat the 58.1 forecast with a read of 59.7. On January 4, the ADP Non-Farm Employment Change report showed the private sector of the economy added 250K new jobs in December. Weekly Unemployment Claims, however, came in higher than expectations at 250K.

On January 5, the U.S. Labor Department reported that the U.S. economy added a disappointing 148,000 jobs in December while the unemployment rate held at 4.1 percent. Economists were looking for non-farm payrolls to grow by 190,000. The total was well below the November pace of 252,000, which was revised up from the initially reported 228,000.

The bright spot in the U.S. December employment report was the rise in wage growth. Average hourly earnings rose 9 cents, or 0.3 percent, in December after gaining 0.1 percent in the prior month. This news lifted the annual increase in wages to 2.5 percent from 2.4 percent in November.

In other news released on Friday, ISM Non-Manufacturing PMI came in below expectations at 55.9.

The Fed minutes revealed the usual divided central bank members, but they also tipped the scales toward the more hawkish FOMC members.

The Fed raised rates a quarter-point at its December meeting, with most FOMC officials backing the continued path of gradual rate hikes. According to the minutes, some Fed members were concerned about low inflation. Others thought the tight labor market and tax hikes could help boost inflation.

Forecast

The jobs data along with two consecutive quarters of GDP growth above 3%, provides a solid fundamental backdrop to support the bull market.

Momentum is driving stocks higher so when the buying momentum stops, the markets will correct. I don’t think this will lead to a change in trend, but it will likely alleviate some of the upside pressure. It will also signal that investors are looking for value.

We also think investors should start preparing for increased volatility. Last year, volatility was nearly nonexistent, as indicated by the VIX index dropping to its lowest level ever.

Let’s look at the Dow for an example, the average is trading over 25,000. Indexes tend to move about 1% per day. This means investors should start bracing for 250 point days. This could mean 125 points up and 125 points down. We may even see 250 point gains, followed by 250 point losses. Furthermore, 2% moves, for example, could mean 250 points up and 250 points down swings.

Whatever, the combination, the point is, be prepared for the return of volatility. If you get freaked out by big numbers then you may want to think about reducing the size of your trading positions.