How solid is this US stock market rally?

It’s been a tough time for financial market commentators lately. It’s difficult having to write about the same thing every day and make it sound interesting.

Some major markets, like the US dollar and oil, have been rangebound, while others, such as gold, are consolidating after record-breaking moves.

In many cases, momentum, as measured by the MACD, has gone from extreme levels, whether overbought or oversold, to neutral ones. 

This makes it difficult to put together an informed view, from a technical perspective, on where some of the most popular markets could be heading next.

The situation isn’t helped by the fact that investors are in a state of limbo when it comes to market-related news.

The majority of the most egregious of President Trump’s tariffs have been postponed.

So it’s now a case of waiting for dribbles of news concerning ongoing trade negotiations to seep out, the most significant being Mr Trump’s beef with China. 

Turning to US stock indices, and concentrating on the S&P 500, arguably the most comprehensive measure of sentiment towards major US corporations.

The index plunged in early April, following President Trump’s announcement of reciprocal trade tariffs.

This saw the daily MACD fall dramatically, ultimately hitting its most oversold levels since the Covid-induced panic of March 2020.

Then, similarly to five years ago, the index found a floor and rallied. The ‘post-Covid’ rally took time to play out, with the S&P grinding higher until it took out its pre-Covid record highs in August, some five months later.

This was impressive, particularly since the pandemic was far from over. 

This time round, the S&P took out its pre-tariff highs in around six weeks. Yet, the problem with this swift recovery from very oversold levels is that it propelled the S&P straight into seriously overbought territory.

Despite this, and following a relatively shallow pullback, the S&P has continued to grind higher.

And while it has yet to recapture its all-time high from mid-February, the index is now less than 2% below this target.

All this despite continued tariff uncertainty, the likelihood that the Federal Reserve may only make one 25 basis point rate cut in 2025, rather than the four anticipated earlier in the year, and fresh concerns over what the Trump presidency could mean for the US budget deficit. 

But there are signs that investors are not quite as sanguine as the current level of the S&P may imply.

The Volatility Index (VIX) is calculated using one-month options on the S&P 500. This makes the VIX a very useful shorthand for gauging investor fear levels, or lack of them.

Last summer, from May through to July, the VIX was happily trundling along in the mid-teens, rarely breaking above 15.

It spiked higher (above 35) as the Japanese yen rallied, thereby destroying the highly leveraged yen carry trade.

But it soon fell back towards 15, and then traded around here, while rarely breaking above 20, until March this year.

In early April, Trump’s tariffs saw it shot back above 35, and, once again, it has dropped down to lower levels. But it remains elevated when compared to recent history, and this should be a warning. 

With the S&P so close to fresh record highs, volatility should be falling. But it isn’t. It seems that investors are willing to pay up and hedge their exposure with pricey S&P put options.

Perhaps that is the cost of trading in Trumpworld, particularly as the tariff deadline approaches. Let’s hope those puts aren’t needed.

(David Morrison is a Senior Market Analyst at Trade Nation. Views are his own.)

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