Specifications, Statistics, and Performance
A stock index represents a basket of underlying stocks. Indexes can be either price-weighted or capitalization-weighted. In a price-weighted index, such as the Dow Jones Industrial Average, the individual stock prices are added up and then divided by a divisor, meaning that stocks with higher prices have a higher weighting in the index value. In a capitalization-weighted index, such as the Standard and Poor’s 500 indexes, the weighting of each stock corresponds to the size of the company as determined by its capitalization (i.e., the total dollar value of its stock). Stock indexes cover a variety of different sectors. For example, the Dow Jones Industrial Average contains 30 blue-chip stocks representing the industrial sector. The S&P 500 index includes 500 of the largest blue-chip US companies. The Nasdaq 100 comprises the largest 100 companies traded on the Nasdaq Exchange. The most popular US stock index futures contract is the E-mini S&P 500, traded at the CME Group.
Source: Barchart CRB Yearbook
Over the past three months, the S&P 500 has returned approximately 10%. During the past 52 weeks, the return has been -7%. Considering the overall bear market that the stock market has been in, these returns seem optimistic. But, is it? Much of it depends on your style of extracting funds from the market.
Fundamental analysis requires studying data such as Federal Reserve interest rate policies, geopolitical events, corporate balance sheets, economic activity (global and domestic), and many other events impacting the perception of the macro view.
Fundamentals have a significant impact on stock prices. During bull markets, the fundamentals are typically bullish (positive). During bear markets, the fundamentals are usually bearish (negative).
And then there are the perceived “pivot” times of market activity. During these periods, market participants begin to expect a change in the predominant price direction of the overall markets, requiring the fundamentals to start changing to support this pivot perception.
During bear markets, there is usually a supply and demand imbalance favoring the supply side (sellers), resulting in lower prices. During bull markets, this same supply and demand imbalance favors the demand side (buyers), resulting in higher prices.
When market participants expect a market direction to change, the supply and demand become more balanced as the buyers and sellers begin expressing their opinions with an equal amount of supply and demand. During this period of equilibrium, market prices exhibit directionless and wandering activity.
The bulls (buyers) and the bears (sellers) have begun a battle using buy and sell orders to express their opinions, resulting in a difficult period for some market participants.
Source: Barchart (SPY Weekly chart)
The S&P 500 has an exchange-traded fund (ETF) symbol (SPY) that allows equity traders to participate using their equity accounts without the need to trade futures contracts. Futures and the SPY ETF are highly correlated.
The SPY chart illustrates a robust uptrend in prices from September 2020 to January 2022. During these bullish market moves, many different trading styles can make money by participating in the markets.
Investors holding for long durations can watch as their profits compound weekly. Traders who follow trends or participate in swing trades can hold positions for multiple durations that fit their profit objectives. Traders can be day traders or overnight position traders. When markets trend, capital appreciation becomes less complicated.
In January 2022, the longest-running bull market in history ended. The initial weekly move into February 2022 lows was a warning that the bull market was in trouble. Soon a lower high rally formed in April 2022 only to retrace and break the February lows resulting in a weekly downtrend of lower highs and lower lows.
Most investors prefer to refrain from participating in down trends by selling short. But, some day traders, trend followers, and swing traders would take advantage of these moves.
But, something happened as the lows of May 2022 (first green arrow) formed. The subsequent rally lasted until June 2022, when it declined (first red arrow). The downtrend remained intact as the market made new lows (second green arrow).
The S&P 500 had fallen to bear market territory of 20% or more below its peak in January. Offering possible opportunities to a contrarian-style trader to buy at these levels, this becomes the first area of balanced supply and demand, resulting in sideways price action. From a sentiment standpoint, this becomes a point where the overall market could be perceived as oversold.
The resulting price rally traded higher than the June 2022 highs, becoming a sideways weekly trend. In August 2022, the supply stripped the demand, and prices dropped to the October 2022 lows (third green arrow). And to confirm that the supply and demand battle was to continue, the demand returned and created our most recent low and trading at our current price of $412.
Will the current rally exceed the August 2022 highs, only to be turned down by significant overhead supply?
While the market could be trading in a sideways trend, another name for the price pattern is a “Broadening Bottom.” This popular trading pattern needs more clarity for a tradable market direction, especially for an investor or trend follower. Day traders and swing traders may find some opportunities to participate.
In a recent article for Barchart, “S&P Futures: Income or Wealth Generation Asset?”, I described futures trading as an income and ETFs are wealth-building styles. As of this writing, the day and swing traders (income style) control this market and its volatility. However, looking at the current market conditions shows that wealth building (investing) will be challenging at best.
Regardless of your path to capital appreciation, being diversified in your portfolio is critical to success. The S&P 500 is not offering extraordinary returns to longer-term investors or traders. But, some other assets and markets are trending and offering opportunities for investors to participate.
Whether a long-term investor or a day trader, don’t marry a particular market; marry your strategy. The strategy can be deployed across numerous other opportunities, but trading just one market limits your long-term goals of capital appreciation.
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On the date of publication, Don Dawson did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.