The S&P 500 isn’t fully recovered from the correction it suffered a month ago, but internal trends indicate the benchmark U.S. equity index is stronger than it looks.
Looking below the surface of the index reveals some notable improvements in market breadth and other technical factors.
Currently, the S&P SPX, -0.13% is about 3.1% below the all-time high hit earlier this year, while the Dow Jones Industrial Average DJIA, -0.62% is 5.3% below its own. (The Nasdaq Composite Index COMP, +0.36% meanwhile, has returned record levels, although it never officially feel into a correction, defined as a 10% drop from a peak.)
Sameer Samana, global equity and technical strategist at Wells Fargo Investment Institute, recently cited improvement in market breadth—or the ratio of advancing stocks to declining ones—as a bullish signal. He noted the Bloomberg Cumulative Advance-Decline Line, which measures breadth of stocks traded on the New York Stock Exchange, had improved since last month’s correction. “This suggests that the worst of the pullback may now be behind us,” Samana wrote, pointing to the chart below:
The S&P spiked on Friday, jumping 1.7% in the wake of a jobs report that showed heavy jobs creation but low wage inflation—“Goldilocks” conditions that analysts said were “just right” for stock-price appreciation. The chart watcher noted that the rally returned the S&P above its 50-day moving average, a closely watched technical level that is often viewed as a proxy for short-term momentum trends. It had closed below that level for seven straight sessions.
According to data from StockCharts, 56% of S&P 500 components are above their 50-day moving averages. This metric can be volatile, and while it is below a recent peak above 80% hit in late January—back when all the major indexes were trading at record levels—the current rate indicates some technical stabilization. In mid-February, during the worst of the correction, the number of components above their 50-day hit a two-year low below 15%. At the start of the month, 30% of companies were above their 50-day.
“We’re seeing better overall progress. There was a concern because market breadth looked like it was deteriorating, but now that’s turning around a bit. The percentage of companies above their 50-day is a sign that we’re getting better internal support,” said Michael Mullaney, director of global market research at Boston Partners.
A similar trend can be seen for the 200-day moving average, which indicates long-term momentum. In late January, when the S&P 500 last traded at a record, more than 82% of components were above this level. In last month’s correction, it felt to 55%, and is currently trading at 70.2%.
Of the S&P 500’s components, 15 are in correction territory, based on current levels. Just three are in a bear market, or 20% below recent peaks. These stats represent massive improvements over just a couple of weeks. In mid-February, nearly a fifth of components were in a bear market—more than the number of components that weren’t in a correction.
While “better internal support” could provide a buffer against additional losses of the type that were seen last month, this doesn’t necessarily mean that equities are primed for a rally.
Morgan Stanley, in a Monday note to clients, speculated that the high hit in January and the low reached in February “about established the high and low end of valuations for U.S. equity markets” for the rest of the year.
“We believe it will prove difficult for the S&P 500 to trade outside of the 16-18x forward 12 month [price-to-earnings] range for the remainder of 2018,” wrote Michael Wilson, the investment bank’s chief U.S. equity strategist.
Currently, according to FactSet, the forward 12-month P/E for the S&P 500 is 17, compared with the 10-year average of 14.3. The trailing P/E is 22, above the 10-year average of 17.1.
“In the near term, we think the P/E range may be narrowing further to 16.5- 17.5x as the market awaits catalysts to take us either higher or lower,” Wilson wrote.
The firm sees both of those presently: “The near term risks of tighter Fed policy and trade tensions are offset by continued strength in economic and earnings data and diplomatic progress with North Korea.”