Published On: Wed, Mar 15th, 2017

S&P 500 ready for a setback? – #SaxoStrats


Our first argument is based on valuation. In terms of trailing valuation (light blue), the S&P 500 looks expensive, but when you look at valuation against current estimates (dark blue), it looks cheap. So what happens when you adjust sell-side analysts’ prediction error on 12-month forward EBITDA (which is -19% in the past year, meaning that analysts have overestimated future EBITDA by 19%)? Well, interestingly, it takes the EV/EBITDA ratio back to where the trailing number is, and the overvaluation becomes clear again. The S&P 500 is clearly in expensive territory, reflecting high earnings growth expectations.

2) Upside risk to Fed’s outlook

The Federal Open Market Committee’s rate decision is due at 1800 GMT, followed by a news conference at 1830 GMT. A quarter-point rate hike is already fully priced in, so the market will pay especially close attention to the outlook for further tightening. Given recently strong economic data, we think Fed chairman Janet Yellen is likely to be forced to acknowledge the recent improvement and may slip into a more hawkish tone than planned. That would be similar to what happened to European Central Bank president Mario Draghi at his recent press conference. A more hawkish stance from the Fed could in the short term cause a repricing of equities because higher rates mean a higher discount rate on future cashflows, but also a less favourable case against bonds.

3) Weaker oil could trigger correction in equities

Yesterday’s big swings in the oil markets gripped equity markets, and it seems equities are beginning to be linked more closely again to the tune of oil markets. Our current view on oil and energy stocks is negative simply because of the excess supply of oil. All the Opec cuts have been plugged by US shale oil producers able to extract oil at these levels due to technological advances in recent years.

4) US economic data could easily disappoint the next two months

Surprises are a mean-reverting process, as can be seen on the chart below. Since the second quarter of 2015 the US economy has outperformed steadily against expectations, and the recent surprises are the biggest in five years. Expectations are now so high that we think the economy can only surprise to the downside from here on over the next months.

Bloomberg Economic US Surprise Index

Source: Bloomberg 

Based on these four arguments we are selling the S&P 500 by buying puts with expiry in May.

Management and risk description

Price momentum is still strong across the board in global equity markets, except for cracks in the energy and materials sectors, down 5% and 10% respectively, in the past two months. It’s always risky to sell something with strong momentum. Our short on Adidas over the fourth-quarter earnings release is an example of that. So we are executing our negative S&P 500 view with puts to limit our potential loss.

SPDR S&P 500 ETF weekly prices
Source: Saxo Bank 


Entry: Our trade idea is executed by buying puts on the SPDR S&P 500 exchange-traded fund, with a strike at $ 237 and expiry on May 19 (65 days from now). This buys us two months for the S&P 500 to stage a healthy correction. Our expectation is a 5-8% correction from current levels.

Stop: the current premium of $ 4.80 (offered) is basically the stop loss. One options contract is 100 times the underlying, so the total premium is $ 480, and thus the maximum loss before commission. That is 2% against the underlying.

Target: our target is set to 2,200 points, which around where the 200-day moving average is right now (2,195) and would translate into a 7% correction in US equities. That would make it a very normal correction historically and something that clears the market before it can readjust higher again.

Time horizon: medium-term with the puts expiring on May 19

— Edited by John Acher

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