The Capital
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The Capital

Is this the Coronavirus Recession or a Fast Recovery?

As consumer sentiment decouples from stock market prices, how do you make sense of it all?

The United States has taken first place for COVID-19 infections and deaths, but there are reports that social distancing has made a difference. In many of the virus hotspots such as New York City, new cases are actually declining. There’s also positive news of a potential vaccine. Meanwhile, jobless claims have reached about 16 million, which is 8–9% of the total workforce of the United States.

The country has just survived the toughest week in terms of battling COVID-19. Hospitals were flooded with much of the population out of work and quarantined or practicing some degree of social distancing not only in the United States but across the world. Against that data, the stock market rallied a shocking 12% for one of the “best weeks” in the market since 1938. That statistic is misleading, however.

If you look at the Dow Jones from previous recessive periods as well as the Great Depression, the market experienced multiple rebounds on the way down. You must consider the context in which those market rallies occurred. In this case, prices rallied powerfully in the middle of an overwhelmingly bearish market.

It’s difficult to imagine the average citizen paying attention to the stock market when so much is at risk for them in terms of employment, sickness, limits on mobility, and any real losses that they may have incurred during the recent market crash. So where is the market’s strength coming from?

Based on the market’s performance last week, the likelihood of seeing a return to all-time highs is slim, but chances are higher that the S&P 500 can enter the range of 2900–3000 before sellers pull prices down further from there. That would be the 61.85% Fibonacci retracement level according to the following snapshot.

Fibonacci retracement levels drawn from the high just before the Coronavirus sell-off to the most recent low.

Price entered the top of an area that was previously supported in August and October 2019, right under the 50% Fibonacci retracement marker. We are at that technical resistance area now. As unemployment numbers increase, there is also the fact that mass testing for COVID-19 is still in development, and there remains the possibility of a second wave of new cases, especially if global social distancing rules begin to loosen. This is exactly what happened in Singapore and China.

When viewing the technicals against current fundamentals, a significant break upward in price from here would be further evidence of a complete disconnect between market prices and world events even when considering the trillions of dollars injected into the economy by the Fed. At the very least, this is a heavily manipulated market.

Did the market factor in 16 million jobless claims as it dropped over 30%?

At a glance, the market shed four years’ worth of gains in reaction to a public health crisis that could be resolved by the end of this year. That possibility is not reflected in global sentiment. The S&P 500 rebounded while the VIX was at an all-time low. For readers who are unfamiliar, VIX is known as the “Fear Index,” and as far back as 2016, it’s traded in a range between 10 and 25 with some deviation due to major global and economic events. Currently, the VIX is hovering well above that range, and I expect volatility in the markets to remain high and price to be bearish until the VIX re-enters its previous range.

Bond markets can provide clues to what’s going on under the hood of the economy. There are different kinds of bonds, but for simplicity, these are fixed income loans with varying levels of risk to the lender.

In terms of risk, “AAA” bonds are of the highest quality, “BBB” land somewhere in the middle, and at the bottom of the barrel are “junk” bonds. The latter is the riskiest of all — junk bonds are composed of companies that are struggling with cash flow or on the brink of bankruptcy.

Last week, the Fed announced that they’ll “do whatever it takes” to backstop the market’s movement to the downside, and part of that plan includes the purchase of junk bonds. This provides liquidity to the bond market just as it was beginning to slide with everything else, but the Fed is only kicking the can down the road in terms of combatting debt and inflation. HYG (an ETF composed of high-yield corporate bonds) responded positively to this news, but if the Fed’s band-aid fails, inflation could spiral within two to four years.

This news is a blessing for lenders such as JPMorgan and Citi, and the announcement was followed by a positive reaction from XLF (Financial Select Sector SPDR Fund). I expect the positive momentum to continue in that sector, which should improve the capacity for these companies to provide loans to small businesses that need it.

Global PMI (purchasing managers index) contracted significantly in response to containment of COVID-19, but the virus is not an outlier. From 2018 onward, GDP in the United States and the rest of the world was already slowing down. The onset of the trade war is still fresh on people’s minds, earnings estimates across the board were slipping, and a pandemic was the needle that popped the bubble.

With the Fed printing unlimited money and rapidly adding companies to their balance sheet, people are beginning to talk of nationalization. The call to bring business home has been an audible part of the narrative for a few years, but with the aftermath of the virus, anti-globalists may have just got an ultimate opportunity.

The Fed now effectively controls about 50% of the overall GDP of the United States. Ford and GM were downgraded to junk and are heavily indebted to the government, an unhealthy signal from the auto industry. Many more companies will declare bankruptcy and the government may step in to save them. That’ll increase government influence on the economy — Are we witnessing the nationalization of the supply chain?

What’s most unsettling is that the amount of stimulus being injected into corporations and the buying of bonds is far greater than what’s being allocated to small businesses. With the national debt per citizen at more than $73,500, many are questioning the true cost of their $1200 checks.

No matter how much the Fed buys, things can’t easily return to pre-Coronavirus normalcy. COVID-19 has changed what ‘normal’ means for many people, and consumer sentiment is crushed. Companies will likely not return to their original productivity levels for at least another two quarters, and that means many of the jobs that were lost will take a long time to return.

There were reports in China that even though their stores began to open and life went back to “normal,” people are now less inclined to go into retail stores. Looking at TomTom data, traffic in Shanghai has dropped 60–70% over the last seven days. H&M in China saw net sales drop by almost 50%, and they completely closed their stores because it isn’t profitable to keep them open.

On a final note, Mexico agreed this weekend to the OPEC cuts in oil production and thus, making this the largest supply cut in OPEC history at 9.7 million BPD. Oil makes up roughly 8% of the United States GDP and employs almost 9 million people. Oil can move equity markets, and it’s likely that rumors of the OPEC deal priced into the market when Brent climbed from $24.5 to $37 over the last three weeks. As oil prices begin to drop, it could pull the overall market down with it.

In summary:

Recent economic events may have already been priced into the market, but on the virus battlefield, there is light at the end of the tunnel. However, this unprecedented government stimulus can only be seen as a temporary fix to a problem that reaches far beyond COVID-19.

In terms of technicals, unless price can find support above the 61.84% area as mentioned, I consider current price action a bear market rally. When comparing last week’s rally with previous historic moves of similar strength, we can safely say that volatility is common in the middle of bear markets. Based on these observations, I would argue that the market continues to sell off.

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