By Hussein Sayed, Chief Market Strategist at FXTM
Ever since the US stock market bottomed on March 23 last year, equities have been driven by brighter growth expectations around the world supported by fiscal and monetary policies, as well as scientists who have worked towards eliminating the virus worldwide.
According to the most recent BofA report, equity funds have attracted $576 bln over the past five months, exceeding inflows recorded over the past 12 years.
Investors have been left with few choices as sovereign debt markets and most high-grade corporate bonds have been offering a minimal or negative real return.
This environment has led valuations to skyrocket with the most followed benchmark S&P 500 trading at 22.5 times forward earnings, well above its 10-year average of 15.9 times and the highest since the late 1990s dot-com bubble.
The upcoming weeks will provide a reality check on whether this bull market still has the potential to creep higher or some profits needs to be cashed out.
The earnings season kicks off this week with major banks announcing first quarter results, a year after the Covid-19 pandemic halted the global economy. As analysts have become more optimistic, earnings expectations for S&P 500 companies have been rising over the past two months and are anticipated to grow 25% in the first quarter of 2021 compared to a year ago.
With bond yields continuing to move gradually higher, forward earnings need to be brought a little lower.
So, either shares prices need to correct to the downside or earnings have to beat market expectations. Given that most technical indicators are reflecting overbought signals on the S&P 500, it seems like earnings will need to beat expectations by a significant margin to justify another leg higher.
JP Morgan, Wells Fargo and Goldman Sachs will all be announcing results on Wednesday, followed by Bank of America and Citigroup on Thursday.
Financials have been the second-best performing sector so far this year rising 19%, with the energy sector topping that with gains of 27% so far this year.
Dollar falls as yields drop
Currency traders will also be closely watching data out of the US this week. The dollar has fallen against its major peers as the US 10-year Treasury yield has dropped from its 14-month peak.
US bond markets have clearly become the number one factor moving the dollar and traders need to watch out to see whether yields will begin rising again following the past week’s declines or possibly consolidate around current levels of 1.6% to 1.7%.
US consumer prices released on Tuesday will be in focus following the largest annual gains in producer prices in almost a decade.
Traders need to ignore the year-on-year changes given the very low base due to the pandemic and concentrate on any monthly moves to determine the trajectory of prices due to fiscal and monetary policies, challenges in supply-chain and expected consumers’ pent-up demand.
Thursday’s retail sales report will also be significant as it should continue to reflect the divergence between consumers spending in the US and the rest of the developed economies.
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