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Wednesday, 21 March 2012

S&P Trading at 1700?

S&P 500 Trading Higher

The last month or so has seen the S&P grind slowly higher amidst incredibly low volatility. The VIX touched a four year low earlier this week as it closed below 15, and all the while the S&P is only trading in one direction – upwards. A recent forecast had the S&P reaching 1700 by year end, which would certainly put it at the top of the range of estimates, so I thought it’d be worthwhile to take a look at how the S&P could possibly take out such a high level in just 9 months.

Firstly, for the record, I think 1700 was chosen for shock value and publicity at much as anything. This seems t have backfired as firstly I decided to take a closer look at the catalysts rather than taking on face value, and secondly I can no longer remember the source. Still, there are some factors under the surface which do have the potential to put a rocket under the S&P like only the Americans could do. Below is a basic chart of the index over the past year:

What Will Drive the S&P

You’ve no doubt already heard the excuses that a mild winter has helped economic data continue to beat expectations and that the economy is back on track for 2% GDP growth, so I won’t dwell on them. What is interesting is the number of open long futures positions is rising rapidly, and especially open COMEX longs in the precious metals space. This is significantly helped by the low interest rate environment which decreases the funding cost for such positions, increasing their potential profitability. It’s no wonder open gold positions have recently hit highs when borrowing is cheap, and the same applies in theory to the index. It’s not always about underlying fundamentals. If 1 million people originally took bets on where the S&P will trade a year from now, making a market of say 1400, an influx of new investors who are skewed to the buy side would push that market up further. Especially if they are leveraged buyers who have held back since the GFC due to high volatility levels making leveraged plays through options expensive. There is a lot of money still on the sidelines, and current investment conditions are looking far more favourable to leveraged buyers of the S&P.

It’s also worth remembering that the current low volatility rally in the S&P is based on US data alone. China has failed to shine like the beacon of hope if became during the GFC and Europe is well and truly in the gutter for the time being. US markets are being stimulated by domestic growth, so if and when foreign markets show signs that they may begin expanding at a faster pace, it could be a case of all the ducks lining up. Growth represents a massive reduction in risk and a large increase to company margins. US companies are fresh from deleveraging during the GFC and cutting costs to far more streamlined levels, meaning every extra dollar in revenue goes straight into the hard earnings and P/E ratios that drive the markets.
Will it happen? My honest opinion is probably not, not this year anyway. There are still a lot of headwinds and 1700 is a long way off. But should the momentum really ramp up, I would be happy to ride the rally for as long as it’s prepared to go for.

In the pipeline: Is it time to take Treasury profits?

Bullish on: Global mining stocks (BHP and Rio Tinto have been beaten down by Chinese fears but the underlying story is still strong)

Bearish on: Crude oil spread (Brent to WTI crude spread is blowing out again, fundamentals suggest $20 would be excessive)

As always, please leave any comments or questions that you may have. If you are looking for a beginner’s guide to trading, please read


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