The S&P has been up four of the last five days, as hopes of a V-shaped recovery continue to expand. It is a natural human inclination to hope that things are improving, which is why all major bear markets have significant countertrend bounces. But are the conditions in place for the market to go straight up from here?
The best argument for a powerful V-shaped recovery is the massive $6.2 trillion in fiscal and monetary stimulus. We have seen the power of central banks many times since the 2008-2009 bear market. Many market players point at the V-shaped bounce that occurred in December 2019. This was a classic V-shaped move and was fueled by a suddenly dovish Jerome Powell.
With stimulus, which was employed many times in 2019, why shouldn't this market go straight back up?
The bear's response to that question is that this crisis is having a significant economic impact around the world. In 2019, the sharp drop was largely a function of the unwinding of a technical trade called 'short volatility'. There was no sudden surge in unemployment or total destruction of corporate earnings. That was all about financial engineering, rather than any real change in the economy.
It is likely that the stimulus moves will help to put a cushion under the market, but to a large degree, it is primarily an effort just to offset the damage being done. But it isn't possible to fix much of the damage that is being done by just throwing money at it.
Currently, the price action is creating optimism, but some of this price action is likely driven by end-of-the-quarter dynamics. This is one of the worst quarters in the history of the market, but many billions of dollars are in funds that are programmed to increase their exposure to equities when that exposure drops below certain levels. Many pension plans have seen their allocation to equities drop and their exposure to bonds rises. Their long-term models tell them to adjust their holdings to a certain ratio. That allocation move is typically taken at the end of the quarter.
While this sort of allocation action sounds like an ideal opportunity for aggressive traders to 'game' the action, it still occurs and has an impact on the market. At the close today, we will see a surge in volume as these allocation trades are closed.
The argument that the market will continue to trend higher on a wave of massive liquidity is hard to dismiss. We simply won't know until we see the price action, however, the bearish arguments are quite compelling.
One of the most compelling arguments is the massive drop in economic activity that is just starting. Unemployment claims spiked to over 3 million last week and will be significantly higher this week. There are projections that unemployment could reach as high as 30%, which exceeds the levels of the Great Depression. The bulls say that this will be short-lived but the emotional impact of this has yet to hit the market.
Corporate earnings will lack visibility for months. No one knows yet when they will be able to fully return to work or how the reverberations will impact growth. The recovery will likely be swift, but it may not be nearly as easy as many are now hoping.
One of the biggest drivers of the bull market over the past decade was corporate buybacks. Tens of billions of dollars helped to drive stocks higher. That catalyst is now gone and won't be back for a very long time.
It is the nature of people to want to believe that problems will be solved quickly and easily. Why can't this be the shortest bear market in history? It is possible, but every significant bear market in the past has seen substantial bounces just like what we are experiencing now. Many folks were convinced that the worst was over just as another down leg commenced.
It is always important to focus on the price action and to let it be your guide, but be ready for this V-shaped action to come to an abrupt end.