S&P 500 Outlook: Will There Be A Market Correction In The Near-Term?

The S&P 500 has soared since the end of March 2020 and is up more than 20% in 2021 alone. Last week, the index notched its 55th record closing high of the year, after rising for the seventh consecutive month in August. The non-stop rally, which has gone all year without a drop of at least 5%, has been fueled by unprecedented fiscal and monetary support in response to the coronavirus pandemic. Retail investors, who have teamed up in social media forums and bought on every dip based on the belief that stocks only go up, have also had a pivotal role in this bull market, which seems overbought by many metrics (e.g., the 14 week RSI indicator is flashing an extreme overbought reading, while the index trades at a ~43% premium to its 200-week moving average).

While it is very difficult to time a correction, traders should start exercising more restraint and caution amid deteriorating market breadth (thin sector leadership), frothy valuations, and some seasonal weakness (as a side note to address the last point, equities have lost 1% on average in September since 1928).

Covid-19, a softer recovery, high inflation and exorbitant multiples all pose risks to stocks, but the elephant in the room that should no longer be ignored is the prospect of higher corporate taxes as Democrats prepare to begin crafting their $3.5 trillion human infrastructure plan upon return from summer recess. While the final package may be smaller than currently envisioned, in order to bring all wings of the party on board, the legislation will have to contain a tax hike to fund an expanded social safety net.

West Virginia Senator Joe Manchin, a moderate Democrat in the 50-50 split upper chamber whose vote is indispensable to moving the White House agenda forward, has urged his party to hit the pause button on the initiative. However, his opposition to the massive bill may just be a strategy to dial back on government spending and force his most liberal colleagues to compromise.

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