Oil Fuels S&P 500 Correction

S&P 500 Downside Risk

The S&P 500 confirmed a technical break to the downside with a close of 6672 on Thursday last week. The decline continued on Friday.

Attempts to stabilise the oil price by releasing strategic oil reserves and lifting sanctions on Russian oil made the headlines last week.

However, oil prices remain elevated, and with Iran claiming that it can keep the Straits of Hormuz closed, that will continue to pressure global oil supply.

That will fuel concerns about inflation and further pressure the S&P 500.

In response, the U.S. 10-year yield rose significantly, raising the spectre of increased borrowing costs.

The balance of probability suggests that a break above 4.5% in the U.S. 10-year yield will likely trigger further institutional selling.

When the S&P falls, the 10-year yield tends to decline as investors seek safety in Treasuries and demand for them increases.

However, the 10-year yield followed the U.S. dollar trajectory.

Warning Signs 

The dislocation in the correlation between the S&P, the dollar index and the 10-year yield last week is a warning sign.

Without a doubt, there will be problems in the global economy.

The impact of the conflict in Iran on supply chains is not fully realised, and, therefore, the impact on the economy is not priced in.

If the conflict continues, earnings expectations will likely be lowered. Margins and capital expenditure will reflect that and could become more apparent in the labour market.

Retail investors have been conditioned to buy the dip. However, now would be a good time to tune out the noise of the news and concentrate on the signals the market is sending.

More specifically, don’t get wedded to the S&P just yet. Keep positioning light and have cash available to respond to extreme moves.

S&P 500 Key Levels

If oil prices, the U.S. Dollar and bond yields continue to rise in lockstep, that is a negative environment for the S&P 500.

In the absence of a cessation of hostilities in Iran, or a Trump ‘smoke and mirrors’ post, a test of 6500 is in play.

That said, the significant rejection in oil prices on Monday does suggest that strong resistance likely sits at current levels and that a bull/bear pivot is at $95.

If you get the trajectory of the U.S. dollar right, then you get the market right. The balance of probability suggests that the U.S. dollar may meet resistance at $102.

Turbulence in the market will continue. Trying to predict what will happen next is natural; however, it should be tempered with patience and a long-term investment approach. The real edge in any investment is patience, not precision timing.