Propped-up by abundant liquidity provided by central banks, all the major stock markets banked impressive returns since mid-March, but the situation had started to change this past week when market participants had to witness a “reality check”. All major indices faced heavy losses on Thursday, as the Federal Reserve did not announce anything new after the last FOMC meeting, and also due to rising COVID-19 cases.
US market hit hard – more downside ahead?
Dealing with overshooting markets had been a real challenge for investors around the world, as valuations and fundamentals had never been so disconnected. What could be the worst recessions since decades ago led to a stock market bubble, driving price to earnings ratios to dangerous levels, suggesting a pop might occur at any point.
The situation is concerning in the United States, where cases continue to rise. The country leads in terms of the total number of cases, and the recent nationwide protests are not raising the near-term prospects. More than 10 different states are declaring numbers above the 7-day average, a concerning aspect for specialists who fear a second wave of the pandemic might be closer than anticipated. If uncertainty will rise again, the US dollar will start to rise and as a result, stocks will be under pressure. Both the Dow Jones and the S&P 500 trading around their 200-day moving average.
As long as new cases will continue to rise, US stocks are vulnerable, since valuations drop each time a state releases negative numbers. Only if numbers enter a plateau could we see a resurgence of risk sentiment, but at the current point, the risk is titled towards the downside.
Bear market rally?
There’s a fierce debate on whether the rally might be an indication for a deep bear market in the months ahead. At this point, it would be hard to anticipate, but the bottom line is that the recent stock market slump had created more uncertainty in terms of the future price direction. Only a strong breakout below the March lows will validate that view, but until then, markets have a long way to go.
Moving ahead, a battle between the easy money policies of central banks and the investors’ fear for a deep recession will take the main stage. No one knows who will prevail, which is why timing trades efficiently will play a leading role. Great progress with a vaccine or cure for COVID-19 will be necessary to alleviate all the tensions and motivate people to spend and thus improve economic activity.