S&P 500: Overbought Conditions, High Valuations Set to Test Bullish Resolve

• Valuation concerns and soft US data may cap upside for S&P 500 in near term.
• August–September seasonality trends historically point to weaker performance for US equities.
• Markets need fresh catalysts as tech-led rallies show signs of exhaustion post-earnings.
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Following Monday’s sharp recovery, US indices fell on Tuesday, but futures were trading higher alongside European markets in the first half of Wednesday’s session. While sentiment towards equity markets continue to remain positive for the time being, that’s not to say things will remain rosy in the coming weeks.

The S&P 500 bias could start to deteriorate in the near-term amid warnings over sky-high valuations against a backdrop of weakening economy as we found out with the jobs data on Friday and ISM services PMI on Tuesday.

Should worries about overstretched valuations start to weigh on a few high flying tech names, most of which have been supported by their latest earnings results, then the major indices could start to show bearish signs. Meanwhile, today’s focus will be on comments from Fed officials Susan Collins and Lisa Cook – their comments may well shape rate cut expectations heading towards the autumn.

But all told, this is a quiet week for economic data. Another catalyst to drive heightened volatility is Donald Trump, who looks to be targeting BRICs nations via trade tariffs and economic sanctions.

What’s Next (LON:NXT) for Markets?

The S&P 500 futures have clawed back around half of last week’s NFP-driven sell-off on hopes the Fed will cut rates sooner rather than later, thanks to weakness in US data. Futures were up slightly this morning, with European shares joining in too. Still, the enthusiasm was somewhat restrained. Obviously, that could change once the cash markets open, but markets could turn more volatile in the weeks ahead.

Seasonality Factors Bode Ill for US Stocks

As equity indices continue to remain near all-time highs, the risk of a pullback amid stretched valuation concerns and technical overbought conditions are increasing day by day. Meanwhile, seasonality factors are also adding to the mix with August and September historically not a great period for US equity prices.

According to Bloomberg, looking at data over the past 30 years, the S&P 500 has tended to lose around 0.7% in each of these months. This doesn’t bode well for the near-term S&P 500 outlook, especially compared with an average gain of 1.1% in other months.

Markets in Need of Fresh Catalysts

So, are we about to see heighted market volatility soon? So far, the dips since markets bottom in April have been shallow and bought quickly, including Friday’s one. While I wouldn’t bet against a bigger fall in the coming weeks, my assumption would be that if markets were to decline, this too would be quickly bought. For now, though, the bulls are still in control, but it is becoming increasingly difficult to justify continued buying without any fresh catalysts.

Indeed, optimism related to trade deals and Trump’s fiscal agenda have been priced in, while the overall positive earnings season also helped keep stocks on the front foot.

Technical Analysis and Levels to Watch

The technical picture is still positive given the higher highs and higher lows observed since markets bottomed in April when the US benchmark index found solid support from the long-term bullish trend line. Fast forward four months and the rally is still going, but with a few warnings signs of exhaustion. This was underscored, for example, by the sizeable wobble at the end of last week.

The daily RSI has since moved below the overbought levels of >70, but the longer-term monthly RSI (not shown) is still above this threshold which will need to unwind eventually either through time of price.

The S&P 500 Futures bounced right where it needed to on Friday to keep the bulls happy: 6240/45 area. This area was important support previously in early July and it held once again. Moving forward, the bulls will need to hold their ground above this zone if they want to maintain control. Lose this and a size dip could be the outcome, with interim support levels seen at 6150/60 and 6070/75 initially, ahead of the key 6,000 handle next.

In terms of resistance levels to watch, well the 6366 level was a key hurdle that needed to hold to keep the bears happy, given that this was the last support pre breakdown on Friday. It held on Tuesday and the index was trading below it at the time of writing on Wednesday, too. A close above it would suggest the bears are losing ground again. Let’s see, though, where we are at in the come sessions. Next resistance is seen at 6,366 and then last week’s all-time high of 6468 will be in focus next.

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