The bear market bounce or relief rally continued through May but might be showing signs of losing momentum. The rally in April came after the initial shock of the coronavirus pandemic and deep and rapid plunge in global equities. Technical analysts will point to the fact that the market was in extreme oversold territory. Momentum behind the rally has built since, as markets have grasped hold of any positive COVID-19 related news that has emanated. Through May the good news continued to out weighted the bad. As the rally continues, investors are beginning to suffer from FOMO – fear of missing out. However, rather than succumbing to such urges, this might be the time when investors should hold their nerve and wait for clearer signs of a sustainable recovery.
At the start of the year we had cautioned that valuations were already stretched, and the double digit returns in 2018 had been driven by multiple expansion. For markets to continue to march forward we were looking for earnings to come through. Equity markets are not far from the levels they saw at the start of the year but with the impact of COVID-19, it is clear earnings support will be lacking, at least for the rest of 2020. Markets might be looking past this to longer term earnings but what is also sustaining the current rebound is, in part, the extreme levels of central bank support.
While the Fed is no longer buying Treasuries at the same rate as in late March, they are still there supporting financial markets. However the market rally which aligned with the FED’s increasing balance sheet has also tapered along with the rate of Fed purchases.
As a result we have an extremely fragile market where volatility, despite having fallen from extreme levels is likely to remain high and cautionary.
With economies slowly reopening there is positive news but there still remains a lot of uncertainty. Australia in particular has managed to contain the spread of the virus and social distancing measures have been taken on board and are proving to be effective. There are some positive signs in the US as well where certain states are also slowly reopening. Mobility trackers show the broad reopening across the globe, although at different rates.
Figure 1 - Google Mobility by Country (excluding Parks)
Percent vs. baseline, average. (Retail & Recreations, Residential, Transit Stations, Workplaces, Grocery & Pharmacy)
Source: Macrobond, State Street Global Advisors Economics, Google as at 10 June 2020.
While things are starting to look better, there are still a number of headwinds to overcome and implications to understand. The real extent of that damage will likely become understood in the next phase, beginning with the number and impact of actual bankruptcies. There is also the risk of a second wave of infections. Although we are better prepared now than we were in March, markets may reprice accordingly on the back of further outbreaks.
The key is to understand that volatility will remain high and uncertainty will continue which will create unpredictability in stock prices. While it might be tempting to see the rally and look to jump back in, holding off a little while longer might be a more prudent approach. Especially in the context of still elevated market levels and high volatility, meaning markets are exposed to a disproportionate amount of downside risk if the recent relief rally ends.
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