Where Will The S&P 500 Go From Here?

The S&P 500 (SPY) is grinding through all-time highs heading into year’s end as the pandemic ravages a third wave in a race for FDA COVID-19 vaccine approvals and distribution. While pundits argue the markets are disconnected with reality, this is the seasonal time of year where liquidity dries up and stocks tend to “melt-up”.

Attempting to explaining the rationale for the market’s price action is akin to constantly trying to fit a square peg into a round hole. It’s also worth noting that five stocks account for literally 70% of the S&P 500 gains, however, the breadth is spreading out rapidly as fund managers frantically scramble to play “catch up” with the 16% performance of the SPY year-to-date (YTD). The SPY has a “perfect storm” breakout pattern in effect which implies higher prices to come. Here’s where the SPY can go from here.

The NASDAQ (QQQ) has been the lead benchmark index ever since it surpassed its pre-COVID-19 February all-time highs of $237.47 on June 5, 2020. While the 16% YTD SPY performance appears impressive, it pales in comparison to the 44% YTD performance of the QQQ. In essence, the SPY is playing catchup to the QQQ. However, the momentum may reverse back into the SPY as the new Biden administration policies take shape.

After the initial COVID-19 induced market sell-off commencing Feb, 19, 2020. Markets bottomed out around Mar. 22, 2020. The markets realized that the stay-at-home mandates created pandemic winners and losers. Companies that enabled remote activities including work, entertainment, learning, engagement and ecommerce saw parabolic spikes in revenues and share prices.

On the flipside, the pandemic losers comprised of companies in the travel, leisure, lodging, mall-based brick and mortar retailers and dining industries. Not ironically, the pandemic winners were mostly found in the NASDAQ 100 companies while the losers were in the S&P 500, growth versus value. The assumption of COVID-19 vaccine approvals and distribution leading to a return to “normalcy” has caused money flow back into the consumer value stocks and pandemic losers. This is further accelerated by underperforming money managers (once again) trying to play catch up jumping into beaten-down stocks, which inherently have more upside than chasing the winners.

The forced shutdown of the economy in an effort to stop the spread of COVID-19 was a form of economic Darwinism, which entrenched the giants while smoking out the less financial stable “mom and pop” small businesses. While the Federal CARES Act temporarily provided a lifeline to struggling businesses, the lack of further stimulus has sealed the fate of countless operations. As small businesses close, it further entrenches the organizations with the deeper pockets and access to funding. This is why so many publicly traded companies in the restaurant sector are seeing their shares rise despite sales being down double digits year-over-year (YoY). The assumption is when the economy recovers, the survivors will emerge with more market share in a stronger competitive position as the pandemic wiped out many of the smaller competitors.

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With such powerful momentum moving forward despite the “froth” in the equity markets, what could cause the markets to reverse back down? Right off the top, if the COVID-19 vaccines don’t receive FDA approval, despite companies like Pfizer (NYSE:PFE) set to distribute its vaccine in the US by mid-December and Moderna (NASDAQ:MRNA) approximately a week after. Markets have already assumed an approval as a foregone conclusion.

Failing approvals would have treacherous implications for both the markets and patients. Which is why, the likelihood of denial is extremely low. The other reaction upon official approval would be a sell-the-news reaction, in which the markets pull the rug on the momentum as they reconnect with “reality”. This is the likely reaction but something that could occur in 2021 rather than into year’s end. Any heavy selling could be met with eager fund managers looking to pick up shares, therefore the pullbacks can be expected to be shallow.

President elect Biden has proposed rolling back the Trump tax cuts notably for corporations as well as raising capital gains taxes back up to 39.5% from 25%. This might compel investors to sell the winners in 2020 and rotate the funds into the losers in anticipation of the tax changes. However, the passage of these proposals relies on the composition of the Senate. If Republicans hold the majority, then the current tax rates are “safe”, but a Democratic takeover may trigger swift profit taking in January 2021.