Three Factors to Watch for the S&P 500 Before Year End

At a Glance

  • Monetary policy, trade talks and the economic picture will ultimately determine the next few months for the S&P 500
  • The 2018 fourth quarter saw the index drop nearly 14%

The S&P 500 has been on a year-long trend up to record highs. The question that should be on investors’ minds heading into the end of the year and holiday season is, will the S&P climb higher or will we have a repeat of the 2018 fourth quarter that saw the index drop 13.5%?

Historically, the fourth quarter has been a boom, returning 3.8% on average since World War II. Typically, the rally continues into the first quarter of the following year which has the next highest average return of 2.2%. This year, the three most important factors to keep in mind when evaluating if this trend will repeat are the Fed, China, and overall economic outlook.

Rate Cutting and the S&P 500

Prior to the 2018 fourth quarter, the Fed had already raised rates three times before raising them again in December 2018 to 2.5%.  We have seen the opposite action in 2019 as the Fed has cut rates three times in an attempt to stimulate markets as signals of a recession have emerged. The cuts have been successful in the short-term, as the S&P 500 rose nearly 140 points at the start of the fourth quarter.

The Fed is not the only central bank in the world that is cutting rates, as the European Central Bank (ECB) and other major central banks have been as well. According to Fidelity, the S&P 500 historically averages a 22% return over the subsequent 12-months when both the Fed and ECB are cutting rates.

The Fed’s decisions to cut rates throughout the year will likely continue to play a key role in the S&P’s performance in the fourth quarter. As investors and funds move away from low-rate fixed income, they will likely flee towards equities and potential higher returns.

China Talks

The ongoing trade issue with China may be the most significant factor in determining where the S&P will land at the end of the year.  The sides are far apart and there doesn’t seem to be an end in sight. The volatility of the geopolitical issue has led to a very high level of uncertainty for investors. Despite this uncertainty, the S&P has continued to climb and could remain relatively unaffected unless talks break down and tensions start rising again.

The 2020 Economic Picture

The overall global economic landscape will be a significant contributor to the S&P’s fourth quarter performance. When the yield curve inverted in August, economists and investors noted that an inversion has been a consistent predictor of each recession over the past 50 years.

Studies show that it generally takes about 18 months for a recession to kick in following a yield curve inversion. In fact, during those 18 months, the performance of the S&P 500 has been robust. It is important to keep in mind that although the S&P has traded at or near all-time highs, there are still signs of a slowdown or recession at some point in late 2020-early 2021. It is also worth pointing out that yield curve has corrected since its inversion in August.

Investors should be mindful of these factors.  The S&P is trading at all time highs and it can certainly move higher, especially in the short run. A dovish Fed, continuing optimism about the U.S. and China tariff war and any uptick in the global economic outlook may just be the catalyst for an end to the year much different than what we saw in 2018.

Scott Bauer graduated with honors from the University of Illinois Business School, Urbana Champaign, in 1988 with a B.S. in Finance. Bauer began floor trading in 1991 and formed BOTTA Capital Management in 1995. Scott traded equity options, S&P options at CME and was employed by Goldman, Sachs & Co. as Vice-President, Equities Division. He is currently CEO of Prosper Trading Academy and appears regularly on CNBC, Bloomberg Financial and Fox Business as a guest commentator.

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