Is this relief rally or a market recovery?
Following the 32% drop from late February, the S&P 500 has bounced back around 20% in the past couple of weeks, driven by:
- A historic oversold condition on the panic
- The prospect of pension fund rebalancing towards equities given the historic decline
- Huge monetary and fiscal stimulus
While that seems extraordinary, history suggests it is right in line with the typical extreme oversold bounce. The median gain of the prior six occurrences of the initial bounce was 17.5% for the S&P 500. As we progress into the second quarter of 2020, the three reasons for the relief rally may now be in the rear-view mirror, yet the global economy still largely remains shut down with the worst of the economic news directly in front of us. Since the global economy remains shut down, we believe the entire gain in markets can be attributed to improving news on the COVID-19 front, and the unprecedented central bank and government action.
Over the coming days, the market will not be as oversold, the pension fund rebalancing has been completed, and the bulk of monetary and fiscal stimulus will have been announced and implemented.
What we want to see in order to expect a market recovery
We had a panic, now we are seeing a relief rally that is typical after a crash. The corporate profit season begins this week, and we should get a good sense of what a shutdown in the economy looks like in the corporate data. Initial corporate releases look very poor so we should expect the market to move back down over coming weeks.
It is on the move back down that we anticipate getting more offensive in terms of committing more money with a high level of conviction. While there could be a bit more upside in this relief rally, we still believe a further downward move in markets is more likely than an uninterrupted move higher.
In order to determine if a pullback towards the previous low is likely to be a positive time to invest we want to see:
- Volatility stay well below the recent peak
- Credit to be sustained and even expand on the recent improvement off crisis levels
- Lower stock correlations to the Index itself
- Better market internals than during the panic phase
Action in portfolios
In terms of activity in portfolios, we have over the past couple of weeks adopted a barbell approach to new investments. We have added some risk via a position in a thematic equity investment tracking companies that derive the majority of their revenues from Cloud Computing, an area of technology that we felt looked relatively attractive given the increased demands for its services under “lockdown”, and beyond. Secondly, we added to our US Treasury Inflation-Protected Securities exposure in the bond allocations of lower risk portfolios. This class of US government bond will help to protect against a spike in inflation potentially caused by the huge stimulus programs underway, and also hedges against a potential fall in equity markets.
Given the extreme levels of monetary and fiscal stimulus, we believe there is a high chance of a strong economic and stock market recovery to follow. However we continue to believe the best case over coming weeks is a period of consolidation, while the worst case is a fall towards the low we reached in mid-March as we move into the heart of the earnings reporting season and receive more economic data that reflects the significance of the shutdown.