Marius Paun | London, UK | Senior dealer | Tuesday, 16th June 2020
Markets suffered a big knock last Thursday with the Dow Jones Index dropping nearly 7% following renewed concerns about the depth of economic damage detailed in the latest Fed meeting. Global cases of coronavirus, now around 8 million, have also supported the selloff. Lately there have been reports that infections are surging in Latin America, southern part of the United States and even China is faced with fresh outbreaks. Throughout last week, the Dow lost 5.5% posting the worst weekly performance since March 20.
On Monday however the Dow recovered from early losses after the Federal Reserves announced further measures to support the markets. They will start buying individual corporate bonds under their Secondary Market Corporate Credit Facility, an emergency lending program that so far had only participated in exchange-traded funds, according to Bloomberg. That is one of nine emergency lending programs announced by the Fed in March amounting to $250 billion that has so far invested just $5.5 billion in corporate bonds ETFs.
In addition, the US central bank said it would follow a ‘diversified index of corporate bonds’ created specifically for that facility. It appears that index was built internally, ‘made up of all bonds in the secondary market, issued by US corporates that meet the qualifying criteria’. Further details are yet to be made public. It feels like it is worth a reiteration of the old saying that investors should not fight the Fed.
Also reacting to the Fed’s announcement, the US dollar moved lower, which should support weak currencies and in turn attract capital flows to them. That could lead to increase economic activity boosting commodity prices. The US stocks should benefit as well since a big chunk of revenues still comes from abroad. US President Donald Trump said so many times that he is in favour of a weaker dollar. The fact that the greenback is down almost 10% since March could mean he’s just getting his way? Surely, re-entering the election campaign means a weak dollar/ higher stocks prices will remain hot targets.
Investor sentiment was further boosted by rumours of more fiscal stimulus with the Dow opening more than 800 points higher on Tuesday. Bloomberg news reported the White House Administration is looking for an infrastructure programme of nearly $1 trillion to help the economy, recently hurt by the coronavirus pandemic. That would require a lot of purchases of commodities, with some likely to experience shortages. Low prices have reduced investments in the sector to a minimum so until a new supply comes online prices will have to rise. Commodities stocks look set for a rise in that scenario.
The Dow was also lifted by the surprise record increase in retail sales for May of 17.7% versus expectation for a 7.7% gain, the biggest monthly jump ever. Meanwhile a potential cheap steroid treatment, which is widely available, shown to be ‘reducing Covid-19 deaths in critically ill patients by up to one third’ according to a recent study.
Going forward there are some specifics that could support Dow even further and by extension US stocks. After 2008 all the quantitative easing moved mostly into financial assets, helping banks’ balance sheets. This time it seems the money is going into real economy through furloughing, tax postponing and other schemes. Some of that will be used to pay down debt but part of it will be invested, spurring increased demand for shares. As the economy picks up the demand for energy stocks should follow, but oil shortages, as a result of the coronavirus, will take time to react. As we mentioned before, reopening oil refineries takes time, hence higher prices until the supply lines readjust.
Lastly, it is worth considering a bit of a psychological issue. QE was supposed to be temporary but it’s funny how many times ‘temporary’ government policy become permanent. If it does not work the first time, they will keep doing it over and over again, flooding the system with more liquidity which has to go somewhere. And with bonds’ yields turning negative, equities should be among the favourites when it comes to beneficiaries.
The chart shows a V shape recovery but yet to reach the all-time high of 29,585 on 12th of February this year. It was an incredible rebound from the lows of 18,165 touched on 23rd of March. A gain of more than 44%. Nonetheless, the short-term moving averages (red line) looks about to cross below the long-term MA (blue line) which would be a bearish signal. The three consecutive downward candles, seen last week, also point to possible further trouble ahead.
On the upside, the first resistance level could be seen around 26,800. The price has already tried to breach that today but the level held, which brought a retracement. A close above this level could build momentum and spur renewed buying. Further upside hurdles should test bulls’ strength of commitment around the 27,000 mark followed by 27,631 the high of the recent rebound. On the downside, 25,800 should act as the first line of support. An even stronger test for the bears is seen just below the 25,000 mark.