Is the rebound in S&P overdone?

Marius Paun | London, UK | Senior dealer | Thursday, 21st May 2020

The US stock markets have posted a decent recovery since the lows of mid-March, supported by unprecedented stimulus packages and promises that ‘Federal Reserves will keep doing what it takes’ to offer liquidity. Earlier in the week, Treasury Secretary Steven Mnuchin, along with Fed chair Jerome Powell, testified in front of the Congress and both said they are ‘prepared to take losses in certain scenarios on the capital remaining to be distributed’. Recently signs that most economies are slowly coming out of lockdown also helped investors sentiment. In addition, US biotech company Moderna showed promising results regarding its trials (although some specialists are challenging the stats). Gilead the biopharmaceutical giant also seemed optimistic about its antiviral medication – Remdesivir, already authorised for emergency use in the US.

S&P 500, in particular, rebounded strongly, currently trading around 2960, which is 35% higher than the March lows at 2184. The rally back was led by technology shares with popular internet shares like Amazon, Facebook, Microsoft reaching all-time highs in recent weeks. Growth stocks, as opposed to value stocks, are running the show again despite their high valuation. Someone joked that no fund manager was ever fired for investing in Amazon even if his timing was not great.

Yet, many investors remain sceptical that this is nothing more than a bear market rally ‘waiting’ for the second wave of coronavirus, which could push stock markets back down to retest the lows. But if one thought before the pandemic the US shares were overvalued, only supported by a Fed willing to intervene at any blip, what has changed this time? Possibly that despite the massive intervention, the economic data looks awful and sliding from recession into an outright depression looks a distinct risk now. Let’s remember what happened:

The US Federal Reserve pledged unlimited asset purchasing to support the markets which mean that money printing, the so-called quantitative easing will not be done to a set amount but rather open-ended. That marked a whole new chapter dubbed ‘QE to infinity’. On top of that, for the first time, the Fed made its move into buying corporate bonds and exchange-traded funds. We also saw Washington lawmakers agreeing a stimulus bill worth of $2.3 trillion to help Americans cope with the negative effects of Covid-19. Individuals could expect to receive $1,200 or $2,400 for couples and $500 per child. At the last FOMC meeting, the Chair Jerome Powell pledged to keep interest rates near zero admitting the US economic activity is likely to drop ‘at an unprecedented pace in Q2’ with double digits unemployment.

The economic data reflected the lockdown and by and large, was worse than expected:

  • First, the US GDP data showed a contraction of 4.8% in Q1 vs -4% consensus.
  • The US retail sales figures indicated a record plunge of 16.4% for April far worse than the prediction for ‘only’ a 12.3% drop.
  • Inflation – US CPI numbers posted a drop 0.8% in April, the largest slump since 2008
  • The US non-farm payrolls data for April released in early May showed the economy shed 20.5 million jobs, slightly better than expected (loss of 22 million jobs) with the unemployment rate rising to 14.7%. The Labour Department reported on Thursday that another 2.4 million Americans filed claims, bringing the total of job losses to nearly 39 million, a historic record.

Nonetheless with all that liquidity flooding the system there’s one particular question in everyone’s mind; when will inflation rear its ugly head? Because rampant inflation is the one thing that the Fed will struggle to control as so much debt will make raising rates (in an attempt to stop it) nearly impossible.

Most economists describe inflation as rising prices as a result of growth in the supply of money and credit. The measure used for that is the CPI – Consumer Price Index. But that only accounts for certain consumer goods and services and it does not include house prices for example. It has been said that the money created following the 2008 credit crisis did not pass into the real economy, instead it moved into financial assets.

This time via furloughs and small loans it looks likely that liquidity is spreading to the points where it was intended. But will consumers be confident to go out and spend as they did before COVID – 19? Many say deflation is still the one to fight in the short term, but come to the end of 2021, possibly start of 2022 we might have a different picture.

rebound in S&P

The chart indicates an all-time high of 3396.88 reached on February 20th. As the coronavirus pandemic spread worldwide, a violent selloff followed to a low of 2184 on March 23rd. That’s a 39% drop in less than 6 weeks. Since then we had a steady recovery, albeit the momentum looks to be slowing now. The short-term moving averages seemed to be crossing below the longer-term one but that was only a false alarm. Both are still pointing upwards.

If bulls can keep the momentum going then look for a retest of resistance around psychologically important 3000 followed by 3100. Next to solid hurdle for the bulls could be at 3195. On the way down 2910 looks as the first line of support. If bears manage to breach that they will target 2850-2870 handle. Good support can also be seen at 2750.