Despite all the “noise” on Wall Street in 2019, the S&P 500 and Dow have continued to climb to new heights. In fact, the S&P 500 and Dow both ended last week just shy of the all-time highs that were set back in late July.
So where do we go from here?
Well, clearly, we remain in the midst of a strong bull market. You may recall that the current bull market commenced back in March 2009. Since then, the S&P 500 has rallied a stunning 332%!
Given the S&P 500’s incredible run over the past 10 years, I’m often asked if the stock market is due for a correction. Personally, I monitor ETF spreads for the SPDR S&P 500 ETF (SPY) and other ETFs, as they served as an “EKG” for the stock market. An EKG measures the heart’s electrical activity and can detect signs of heart disease. The SPY serves the same purpose for the stock market. The reality is that when there’s a wide spread between buy prices and sell prices for these ETFs, it can trigger arbitrage and a stock market correction.
But, based on current ETF spreads, there isn’t a market correction in sight.
Consider this: The folks at Bespoke issued a fascinating report on SPY last week. The SPY is the oldest and largest ETF based on the S&P 500. Back in 2018, SPY climbed 21.4% in after-market hours, but it declined 8.7% during market hours. So, in theory, if you bought SPY at the close and sold it at the opening since 2018, you would be up 30.1% (21.4% + 8.7%) due to the price anomalies associated with ETF spreads. You can see this in the chart below.
These ETF spread anomalies were especially acute in the fourth quarter of 2018, which caused arbitrage traders to buy at the close and sell at the opening in order to capitalize on the wide ETF spread prices. This ultimately caused the stock market correction in the fourth quarter of 2018, despite record sales and earnings announcements for the S&P 500.
Fast forward to 2019. So far in 2019, Bespoke reported that SPY has risen 7.4% during after-market hours and 10.2% during market hours. In other words, there isn’t any significant price anomaly. In addition, the ETF spreads on SPY and other major ETFs are currently a lot tighter and more orderly.
So, based on my EKG indicator for the stock market, there is no sign of an impending heart attack—there isn’t any excessive arbitrage trading or market correction in sight. The coast is clear for a nice yearend rally in the upcoming months.
I still expect the third-quarter earnings announcement season to serve as a launching pad for this yearend rally. The reality is that third-quarter earnings will represent the trough for the S&P 500’s earnings. According to FactSet, S&P 500 companies are expected to post a 4.7% decline in third-quarter earnings, and sales are forecast to grow 2.6%.
The good news is that about 15% of S&P 500 companies have released results so far, and 84% of these companies have topped analysts’ earnings estimates. And 64% have beat sales forecasts. So, I fully expect more positive earnings and sales reports to propel the stock market higher in the coming weeks.
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