Navigating the stock market always involves reconciling logic with price action. What may seem like common sense may not apply at all on any given day.
The current environment offers a particularly good illustration of how difficult it can be to use what seems like simple logic to navigate the market. We are dealing with an unprecedented crisis and an economic collapse unlike anything anyone has ever seen, yet the market is trending upward and acting like this whole issue is going to quickly pass.
There are plenty of explanations for this positive price action. First and foremost is that the Fed has created massive stimulus. A big portion of those funds is going to flow into equities and it doesn't much matter what valuations might be.
Another reason for continued upside right now, is poor positioning. Many market players have not been anticipating a giant V-shaped move and they are scrambling trying to keep pace. Many of them have big losses to make up and are very fearful that they are missing out if they aren't heavily long right now.
The main explanation for the bounce in futures overnight was that Chinese exports dropped only 6.6% in March versus the 15.9% that was expected. This is supporting a belief that the economy is on track to recover much faster than many had anticipated.
Right now there is an optimistic view of how quickly the U.S. will recover from this crisis but that view is likely to change as earnings reports start to roll in. Big banks kick off earnings season Tuesday morning. JPMorgan Chase (JPM) and Wells Fargo (WFC) will report before the bell and will provide speculation of what lies ahead.
In a number of ways, the current market action looks similar to what occurred in mid-February. The indices were hitting new all-time highs as the coronavirus raged in China. Market players were scratching their heads at the positive price action and many of them attributed it to the Fed's overnight repo program, which was steadily feeding billions of liquidity into the market.
Eventually the reality of the coronavirus news took hold in the U.S. and the indices collapsed. In retrospect, it was extremely obvious that it would occur but market players were blinded by the strong price action.
Similarly there is another major negative on the table right now and that is the economic damage being done. It is being covered up right now by optimism about the Fed and the pace of recovery but our job is to watch for a shift similar to what happened in mid-February. Earnings season will likely be the catalyst.