S&P Futures expected to be range-bound with bearish bias in medium term

THE E-mini S&P 500 Futures contract rose by 0.77 per cent for the week of Apr 14 and is up about 7.76 per cent year to date. The contract has rallied since mid-March 2023 as the US banking turmoil caused markets to increase bets that the Fed would halt its tightening campaign and cut rates earlier than expected. An encouraging March Consumer Price Index report, a surprise decline in the Producer Price Index and a projected “mild recession” in the March FOMC meeting minutes further cemented this view.

The bullish momentum appears to be fading as the interest rate outlook has turned more hawkish, following stronger-than-expected earnings from large US banks, a sharp rise in near-term inflation expectations, and hawkish comments from the Fed officials. At the time of writing on April 19, 2023, according to the CME FedWatch Tool, there is an 88 per cent probability for a rate hike in May 2023, up from 20.7 per cent a month ago. Crucially, market expectations for rate cuts have once again diverged from the Fed, with the bond market pricing in two rate cuts by the end of 2023. We believe this could serve as a source of volatility for stock markets.

In our view, we expect the Fed to hike another 25 basis points in May 2023 due to recent oil production cuts by Opec+, a still-tight labour market, and sticky core inflation. Thereafter, we envision an extended pause before the Fed cuts rates in 2024. With the economy still surprisingly healthy, markets may price out the expected rate cuts later this year, leading to a possible rally in Treasury yields that may exert downward pressure on the stock market.

Fundamentally, we maintain a bearish outlook on the contract as we believe that it is unlikely for the Fed to meet market expectations for rate cuts in H2 2023. At the same time, we forecast a poor Q1 earnings season and downbeat forward guidance. Earnings estimates have been on a downward trajectory since June last year, while tighter credit conditions should negatively impact capex and stock buybacks to keep stock fundamentals weak.

We also forecast a “good news is bad news” backdrop. The E-mini S&P 500 Futures contract could see renewed downward pressure if economic data suggests the US economy remains resilient, giving room for the Fed to continue hiking rates. Alternatively, data pointing to a deteriorating economy could prompt the Fed to ease monetary policies, which may spark a stock market rally.

On a technical perspective, the E-mini S&P 500 Futures contract appears to be in consolidation since December last year, possibly awaiting a fresh catalyst to trigger a bullish or bearish breakout. Major resistance is found at the 4,200 level, which has not been breached since August 2022. For the remainder of April 2023, we expect continued volatility and choppiness, with the contract trading range-bound 4,200-3,800. Our view of a sideways market is supported by the Average Directional Index (ADX), a trend strength indicator which is derived from the Directional Movement Indicator (DMI) line. The ADX indicates that a security is in an uptrend or downtrend if it is above 25. It also signals that the asset is moving sideways if it is below 25. ADX values of 19.90 validate our view of a sideways market.

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Nevertheless, in the foreseeable medium term, we maintain a bearish bias on the E-mini S&P 500 Futures contract, with the Q1 earnings season and upcoming economic data serving as the fundamental triggers needed for a bullish or bearish breakout. Technically, we lean towards a bearish breakout because the 14-day Slow Stochastic Oscillator, a momentum indicator, signals overbought conditions as it is above 80, with the %K line around 81.7. There is also a bearish crossover signal, with the %K line having crossed below the %D line in the overbought region.

Therefore, we hold a bearish outlook on the E-mini S&P 500 Futures contract in the medium term. We forecast solid economic data and a disappointing Q1 earnings season to push the contract towards immediate support at 4,100. If breached, expect our thesis to further materialise with further drops to around the 4,000 level, which corresponds with the 38.2 per cent Fibonacci retracement of the 2022 decline. A break below the 4,000 level could see the contract head further downwards towards the 23.6 per cent retracement level at 3,810/3,800. Alternatively, a strong Q1 earnings season and weak economic data may push the contract above the 4,200 level which, if broken, could see further upside towards retracement level at 4,310/4,300.

The writer is investment analyst at Phillip Nova