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US stock market analysis: the three major indices are rising, how can investors exploit these opportunities?
Lucia Han
2020-08-28 766

Abstract: The three major U.S. stock indices have made spectacular gains recently, with the Nasdaq and the S&P 500 index hitting successive all-time highs. Although the Dow has yet to break its record, it is now above 28,000, just shy of its all-time high. Nevertheless, economists and financial gurus become extremely concerned about any abnormal performance of U.S. stocks since the outbreak of the COVID-19 pandemic and four circuit breakers in the U.S. stock market, and they have warned that most of stock prices are out of line with the fundamentals. But their warnings have not dampened investors' enthusiasm for the US stocks. So what's driving the index rally?

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The Fed's new stimulus package which is scheduled to come soon

The Fed, the central bank of the United States, provides the nation with quantitative easing to push U.S. stocks higher. Since the outbreak of the pandemic, the Fed acted quickly to inject liquidity into financial markets and thus greatly stimulated the U.S. stock market, especially by purchasing in the secondary market corporate bonds. Meanwhile, the Chairman of Fed on  Jackson Hole Symposium, announced new approach to inflation that could keep rates at average inflation target, which means Fed may not hike interest rate before meet this inflation target. 


Therefore,the liquidity has increased the spending power of businesses and individuals and contributed to the rapid growth of U.S. economic indicators. But devaluation of U.S. dollar and sharp fall in Treasury yields ensued with incremental dollar liquidity, leading to a huge shift of capital from fixed income to risk asset investment, as illustrated below:


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Source from: Trading economy.com


As the figure showed, the S&P 500 moved almost inversely to Treasury yields since May. Gold and silver prices are experiencing a deep correction, which makes people more cautious about investing in the metals. Meanwhile, the Fed's stimulus package is far from over. A new stimulus bill, scheduled before August 7th, has yet to be unveiled as partisan negotiations collapsed, and is expected to be reached in September. The bill could then continue to support the rally in U.S. stocks.

Sino-US relations to which the U.S. stock market is highly sensitive

Sino-US relations have plunged to such a freezing point that some scholars even compare it to the Cold War between America and the Russia. The rivalry between the two huge economies has spilled over from trade disputes to technology and finance. The Trump administration, for example, requires Chinese companies listed in the U.S. to undergo tougher accounting scrutiny from the U.S. Securities and Exchange Commission. This has not only caused wild swings in the share prices of U.S.-listed Chinese firms, but has also sent panic through the U.S. stock market. 


However, a telephone conversation held by US-China chief trade negotiators a few days ago led the three major U.S. stock indices to top other financial markets and sent the NASDAQ and the S&P 500 to record highs. The relationship between China and the United States may not thaw any time soon, and both parties' retaliatory comments will continue to rattle the U.S. stock market.

Falling new infections in the U.S., and the attempt to speed up vaccine approval

Currently, new cases of novel Coronavirus in the United States is on the decline. A total of 297,000 new cases were reported in the week ended Aug. 23, down from a weekly peak of over 468,000 in mid-July, according to the Centers for Disease Control and Prevention. This coincided with the first time since early June that the average number of new cases in the country has fallen below 50, 000 per day, as shown below:


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Source from: Centers for Disease Control and Prevention


In addition to the good news of virus prevention and control, new progresses have been made in vaccine R&D. First up, Russian President Vladimir Putin announced in mid-August that Russia had registered the world's first vaccine for the coronavirus. Second, the Trump administration is considering rapid tracking of the Coronavirus vaccine developed in the UK for use in America. Despite skepticism, U.S. stocks soared. Thus, as the COVID-19 abates, investors may be more willing to flock into the U.S. stock market.


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The U.S. Presidential Election which is approaching and leads to stock market fluctuation

The quadrennial U.S. presidential election approaches and the volatility of the election year is not to be underestimated for the U.S. stock market. Looking back at the 23 elections since 1928, the S&P 500 has performed positively in 17 (with a probability of about 74%) election years, with an average annual return of 7.1%, according to Schwab Center for Financial Research. However, backward reasoning seems more intriguing and suggests that the U.S. stock market has a more direct effect on elections: when the S&P 500 rose in three months leading up to an election, the party in power usually won the White House, while it lose when the S&P 500 fell. In spite of regularity to such reasoning, it seems to be wild speculation based on probability alone. At the same time, due to the sudden outbreak of COVID-19 this year, Black Swan events are frequent and normal, even if they break the historical rules. In brief, the U.S. presidential election does fluctuate specific sectors of the stock market, and can even rise investment risk. (Source from: www.schwab.com)

Will the three major U.S. stock indices continue to climb?

1. This month of the earnings season witnessed the S&P 500 hitting several record highs. While the COVID-19 pandemic made quarterly earnings expectations for U.S. companies severely pessimistic, Wal-Mart Stores Inc., Home Depot Inc., Target Corp. and some other big retailers in fact beat expectations and posted big gains, thanks, of course, to the Fed's helicopter money, the S&P 500 index reported. Despite this, it's worth noting that only 38% components from the S&P 500 index are up significantly, while other value stocks remain flat. As a result, successful implementation of the Fed's fiscal stimulus package will most likely push the S&P 500 higher.


2. The COVID-19 driven covid economy is developing fast and has helped push the NASDAQ index to new highs. Companies of social networking platforms, cloud computing, and streaming media have become pivotal support for the NASDAQ to soar to record highs. For example, the health-care sector, the second most heavily weighted stock on the Nasdaq, performed well but is highly volatile. Also, shares in the renewable energy sector rose after Democratic presidential candidate Joe Biden spoke out in support of the campaign to fight global warming and encouraged application of renewable energy. The Nasdaq-100 Index was the star performer, as it is heavily concentrated with technology companies. Its reason seems logical. The COVID-19 pandemic has made investors gravitate toward tech stocks, and less virus-affected tech magnates serve the inclination.


3. Although the Dow underperformed the S&P 500 and the Nasdaq, it looks on track to break its all-time high. Apple's weighting in the Dow will fall sharply after the company's announcement to implement a four-to-one stock split on Aug. 31. It would boot Apple’s Dow ranking all the way down from 1st. Apple brought its 2020 gains to nearly 70%, contributing to Dow's about 1200-point climb. As a consequence of the stock split, the Dow would have struggled to catch up with the S&P 500 and the NASDAQ. To respond to such case, the Dow made its biggest adjustment since 2013, removing ExxonMobil, Raytheon and Pfizer from the index while adding Saleforce, Amgen and Honeywell. Afterwards, the Dow may have a better chance of breaking through its historical price.


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Technical analysis of the S&P 500

As of Aug. 28, the S&P 500 had notched up six straight gains, breaking its February high of 3,397 and climbing to its current high of 3,450. The MACD illustrated that the 12-day exponential moving average (EMA) crossed the 26-day EMA and remained upward, which indicates the strong upward momentum of the S&P 500. It thus is expected to knife to all-time highs atop the 3,500 mark and continue to rise, as shown below:


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Source from: Mitrade


Notably, the current RSI is considered overbought for the S&P 500 since it is 78. Therefore, short-term investors need to guard against the risk of short-term overbuying.


To sum up, following the earnings season is heightened investor optimism that novel Coronavirus will stunt economic growth, which is fueling the U.S. stock market. Meanwhile, it seems unwise to go short on U.S. stocks when good news from U.S. economic data is adding more fuel to the market. In addition, the new stimulus package has yet to be enacted, so if it arrives as scheduled, it will be another shot in the arm for U.S. stocks as expectations for the bill remain high. While both fundamental and technical analyses are biased towards an upside trend of the U.S. stock market, investors still need to keep an eye on the risk of volatility from the U.S. election.


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