Equity markets rallied strongly last week despite another Friday sell-off that saw selling accelerate in the last half hour of trading, which might indicate an unwillingness of investors to hold long equity positions going into the weekend. Despite the Friday weakness in stocks, the S&P 500 rallied 18% this week and posted its best 3-day return since 1933. The only other two 3-day periods that did better occurred during the Great Depression.
The Great Depression and 2008 Great Financial Crisis narratives surface often these days when trying to characterize the current market environment and project a path forward. In fact, there is already a consensus forming that, as in 2008, last week’s rally in stocks was a bear market rally that will ultimately fail and see equities retest and breach the recent market lows. As the chart below shows, the S&P 500 bounced higher six times by at least 9% between September and December 2008, with some rallies as large as 19% and lasting in duration between one and six days. And, like last week, most bounces in 2008 involved optimism around monetary or fiscal policy support.
Rather than speculate on the path of the current bear market and how it may follow the paths of previous bear markets, it would be more instructive to try and glean insights from last week’s market action. Certainly, it felt like the quarter-end pension fund rebalancing I mentioned last week contributed to some of the buying demand in equities. To put some numbers around this rebalancing, the relative underperformance of equities to bonds on a month-to-date basis to last Monday’s close was the largest in over 25 years. Morgan Stanley projects that pensions will need to buy $100-$110 billion of global equities to rebalance 100% back to target equity weights by March month end.
Also worth noting was the 6.24% surge in the S&P 500 last Thursday when a record 3.28 million Americans (more than 2% of the employed population) filed for unemployment benefits for the week compared to consensus forecasts calling for 1.7 million. Considering how strongly stocks rallied after the release of this horrible news, it would appear that investors were expecting an even worse number, perhaps in the 5 – 7 million claims range. We may see these higher figures in the weeks to come as there were suggestions that state websites and phone systems struggled to cope with the volume of applicants, implying that last Thursday’s figure understated the number of people losing their jobs.
On volatility, the spot VIX level settled down to the 60’s range after hitting an all-time high of 82.7 two weeks ago. While the 60-70 range is still extremely high, the VIX futures curve is confirming the relatively calmer environment as front-end volatility fell, perhaps indicating that forced liquidations and the most intense period of the sell-off may be behind us.
Credit markets showed improvement last week as investor appetite was strong for new investment grade corporate bonds issued by McDonald’s, MasterCard and Comcast. In fact, these companies were able to issue the bonds at much lower yields than their initial offers. Bond ETF’s, such as the iShares iBoxx Investment Grade Corporate Bond ETF (LQD), also saw large inflows last week and traded at its largest premium to net asset value after trading at its largest discount the previous week. Part of the reason for this may be investors front running the U.S. Federal Reserve as the Fed announced last week that it would buy shares in investment grade corporate bond ETF’s in its efforts to support liquidity.
The swift and large fiscal and monetary policy response has matched the speed and magnitude of the decline in economic activity and equity prices. This policy intervention is necessary to curtail tail risks, although it’s unknown at this point whether the magnitude of the policy response is sufficiently big enough to prevent a deeper recession.
Perhaps unsurprisingly, equity markets rebounded sharply last week due to many possible factors including pension fund rebalancing, short covering, confidence in the “do whatever it takes” stance of the monetary and fiscal policymakers, and investors anticipating the slowing of the COVID-19 spread. As we look ahead, investors will face a deluge of companies starting to report their Q1 financial results that have been affected by the COVID-19 pandemic.
With the good news around the monetary and fiscal policy response now behind us, investors will look to company fundamentals and economic readings to debate the path forward for equity prices. For long- term fundamental investors like us, this will be a welcome change from a market that has lately been trading on technical factors and weighed down by fear and uncertainty.
Lieh Wang, Chief Investment Officer,
iA Investment Counsel Inc.
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