The S&P 500 has rallied since February 12 on expectations that the U.S. economy will continue to muddle along. Its recovery from a 16-month low was supported by an increase in the appetite for risk, as measured by the ratio of oil to gold. Their tandem strength should continue while the index and the ratio hold above their 21-day exponential moving averages.
Source: Thomson Reuters Eikon
Who’s to blame?
The S&P 500 index encountered unprecedented weakness early this year, forming two significant lows on January 20 and February 11 in the 1,810 area. Blame it on China, blame it on low oil prices, blame it on the prospect of rising borrowing costs in the U.S.
The Chinese economy is not going to bounce back to its record rates of growth, but it’s not expecting to implode, either. However, the prospects of a recovery in oil prices vaulted spirits worldwide.
The ratio of oil to gold can be considered a risk on/risk off indicator because increased demand for oil suggests rising industrial production (risk on), while a rise in gold oftentimes suggests the need of hedging (risk off). So, a rising oil/gold ratio should indicate an increase in the appetite for risk, and a declining ratio should show adversity to risk. The Saudi-led overproduction of oil for political reasons skewed the significance of this ratio; however, the markets were rife with rumors that oil drilling will slowly be reduced.
These rumors, which eventually turned into expectations, vaulted the oil/gold ratio above its 21-day exponential moving average for a longer period, and this newfound appetite for risk extrapolated to the S&P 500. The index climbed above its 21-day exponential moving average on February 17 and never looked back.
The S&P 500 also advanced above 1,972, the 50% retracement of the downtrend between July 2015 and February 2016. For as long as the index holds above its 21-day exponential moving average, currently at 1,952, the appetite for risk should remain relatively strong.
Immediate resistance is seen at 2,011 from the 61.8% Fibonacci retracement. However, traders would surely like to re-test the series of declining tops in the 2,080 to 2,135 area.
