Why I Don’t Trust the Rally

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If you look just at the chart, there are a lot of encouraging signs for stocks right now. The S&P 500 hit its low on March 23, exactly three weeks ago, and has recovered around half its losses in that short time. If this morning’s pre-market rally lasts, we will end the day with a clean break above the 50% retracement level which would suggest further gains. For several reasons, though, I don’t yet trust the rally.

SPY 1YTD

First among those reasons is simple logic.

The rally is presumably on the assumption that the end of the coronavirus pandemic is in sight. I guess it is in the sense that we know that at some point we will be looking at it in the rear-view mirror, but, as far as I can tell, that point isn’t here yet.

The rate of increase in cases and deaths here in the U.S. may be slowing, but that doesn’t mean that we are close to rebooting the economy. There is some big talk about “re-opening” coming from the White House, but what does that mean? Some governors are already resisting the notion that restrictions could be lifted soon, but even if those objections are overcome, that doesn’t necessarily mean that people will be going back to work.

What were previously everyday things will now give a lot of people pause. Can you imagine getting into a crowded elevator right now to go to your office job? Or boarding a crowded train, bus or subway car to get there?

I am sure that once a reliable treatment and/or a vaccine are found and are freely available, life will return to normal. We just aren’t there yet, though.

That is why other key markets aren’t exhibiting the optimism of equities. Oil is still depressed, for example, despite massive output cuts from OPEC+ and mounting evidence that U.S. shale production is also in sharp decline. Crude futures did bounce a little starting a week after stocks hit their low but has since given back most of those gains and is looking likely to retest the lows before long. Clearly global oil traders, who look beyond the level of optimism in America, are still worried.

In addition, gold is at multi-year highs and Treasury yields bobbing around all-time lows, both indicators that there is plenty of fear out there. That is hardly surprising given what is being said by those who consider the global outlook.

The OECD has said that the economic effects of the reaction to the virus will be felt “for a long time.” The WTO is forecasting a massive hit to trade and, just this morning, the IMF said that we will “very likely” suffer the worst recession since the 1930s.

And yet, in the U.S. stock market, the focus is on the prospect of a booming recovery in the second half of this year, as Goldman Sachs is predicting. They anticipate an economic shock four times worse than that of the financial crisis, but a rapid bounce back.

In that scenario, stocks at these levels makes sense to some extent. It is an example of the market performing one of its normal functions, looking forward. However, it ignores another important one: accounting for risk.

I certainly hope the optimists are right, but with a very real risk that the economic effects of all this are longer-lasting than Goldman’s prediction and none of that risk priced in, I will take the chance of missing out a bit and wait for a better entry point before buying again.

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