S&P 500 analysis: Can strong momentum continue in Q4?

The S&P 500 is about to close out the third quarter and unless it stages a sudden 5% drop in the next few hours, it will finish higher for the fourth consecutive quarter. Its gains have been truly remarkable. Our S&P 500 analysis suggests a correction is long overdue, but we need to see a reversal pattern first before we try to call any sort of a make top. But heading to Q4, there are plenty of risks to consider, including the market being too optimistic with the Fed’s rate cuts and on company earnings results.

S&P 500 short-term risks skewed to downside

Indeed, with the bullish momentum so strong during this bull market, one has to see evidence that the momentum is weakening first, before expecting the market to drop. That said, with geopolitical risks and uncertainties rising, given the deteriorating situation in the Middle East and upcoming US election, and not to mention the upcoming Q3 earnings, the risks remain skewed to the downside from here in the short-term outlook.

S&P analysis: Strong momentum heading into Q4

Heading into Q4, the S&P 500 is now up for 7 out of the last 8 quarters, and up for the fourth consecutive quarter and fifth month. It has surged by over 33% over the past year, marking its biggest gain since October 2021. In recent history of the last 10-15 years, we’ve only seen stronger performances twice—during the bull markets of 2010 and 2021. Those were periods when stocks made a historic comeback following the 2008 Financial Crisis and the pandemic crash of 2020. The index has already set 42 record highs year-to-date, positioning it for the second-strongest streak since 2017.

Against this backdrop of a momentum, trying to time the market top is no easy task. But with momentum indicators like the RSI all pointing to overbought technical correction, we do expect to see some weakness in the market, even if it ultimately proves to be just another short-lived drop. 

S&P 500 technical analysis

Source: TradingView.com

While a sharp sell-off is inevitable at some point, for now, the bulls remain in charge given the higher highs and higher lows, rising moving averages and trends lines etc., on  on the S&P 500 chart.

There are now several key technical levels that could serve as support in the event of a market pullback. The most immediate short-term support lies around the 5725 mark, where the index encountered resistance before breaking out. This level was being tested at the time of writing. Below this level, the next significant support zone is at 5670, the previous all-time high from mid-July. Further down, 5613 marks another important level to watch. A drop below these key zones could signal the beginning of a bearish trend, but for now, the bullish momentum remains intact.

On the upside, if the rally continues, the next target is the 5827 level, which corresponds to the 127.2% Fibonacci extension of the last significant downswing observed in mid-July.

While the daily Relative Strength Index (RSI) remains just below the 70.0 threshold, the monthly RSI has crossed above 70.0, reaching its highest point since January 2022. Historically, such readings have preceded multi-month bear trends, but even greater overbought levels were reached in recent history – for example, in August 2021, September 2018, and January 2018 – without immediately triggering significant downturns. Although an overbought RSI is not necessarily a sell signal, it serves as a warning that a correction or consolidation could be looming, especially as we move into Q4 with the US elections and Q3 earnings on the horizon.

Fed’s expected rate cuts are being priced in

In the US, the Federal Reserve cut interest rates last week, following the lead of other central banks, signalling the potential start of a broader rate-cutting cycle. Currently, markets are pricing in a 62% likelihood of a 50-basis point rate cut at the Fed’s November meeting, which continues to support bullish market sentiment. However, incoming data will impact those probabilities, which means the Fed may go ahead with a smaller cut than expected. What’s more, the Fed’s expected efforts are being priced into the markets, which means further sharp gains might be difficult to come by – especially if growth concerns intensify. Ultimately, company earnings and forecasts may not be as optimistic as the markets, which means the risk of a correction is high.

JOLTS Job Openings could steal the show (Tuesday)

Among this week’s key US economic data, the JOLTS report on Tuesday could be the highlight. With the Federal Reserve’s focus shifting from inflation to employment, this report takes on extra importance. The Fed’s aggressive rate cut in September has already shown their concern over a weakening job market. If the trend continues, it could increase the probability of another 50-basis-point rate cut in November, applying additional downward pressure on the dollar and support for equity markets. Pay close attention to employment metrics in the ISM services and manufacturing PMIs for further clues. But with much of the rate expectations in the price, you do have to wonder how much of a further lift these figures will give to the market.

US Non-Farm Payrolls should impact Fed’s November decision (Friday)

This will be the highlight of the week, make no mistake about it. In August 2024, the US economy added 142,000 jobs, falling short of the 160,000 forecast. Revisions to previous months showed July's figures lowered by 25,000 and June’s by 61,000. However, the unemployment rate dropped to 4.2%, while average weekly earnings exceeded expectations, growing by 0.4%. Concerns about the labour market prompted the Fed to cut rates by 50 basis points in September. If job growth continues to cool, it increases the likelihood of another 50-basis-point cut in November, further fuelling the reflation trade. However, a surprisingly strong jobs report could shift market expectations sharply.

-- Written by Fawad Razaqzada, Market Analyst

Follow Fawad on Twitter @Trader_F_R