Relief rally or bear market bubble? For investors, it's hard to tell

  • By Saqib Iqbal Ahmed and Ira Iosebashvili,
  • Reuters
  • Facebook.
  • Twitter.
  • LinkedIn.
  • Print

What started as a bear market bounce in U.S. equities has transformed into one of the most dramatic rallies in memory, leaving investors looking to past rebounds, options markets and technical analysis for clues on how far it could run.

The S&P 500 (.SPX) is up 37% since its late March close as of Monday and the Nasdaq Composite (.IXIC) is near a fresh record after a surge that has seemingly ignored widespread economic upheaval and uncertainty over the coronavirus pandemic.

The rally’s speed has left investors in a quandary. While few are willing to bet against a rebound that has steam-rolled most forecasts, some are concerned the market has become detached from economic reality by expectations of unlimited support from the Federal Reserve and U.S. lawmakers.

The S&P 500, for instance, now trades at 21.2 times earnings, its highest level since 2002, even as unemployment is at levels last seen in the Great Depression. A Reuters poll showed investors expect Friday’s U.S. employment data to show a loss of 7.45 million jobs cut in May, after a record 20.5 million in the previous month.

U.S. stocks rose Monday after days of widespread protests and civil unrest over racial inequities and excessive police force.

“We’re in a different game and trying to establish what is fair value is difficult,” said Alan Ruskin, chief international strategist at Deutsche Bank.

Those looking to history believe the split between Wall Street and Main Street is unlikely to last. The S&P 500 has never reached a bottom in less than six months after falling more than 30% during a recession, according to a study by BofA Global Research looking at markets over nearly nine decades.

If that dynamic holds true, it means the S&P is due to eventually revisit its March 23 low of 2,191.86, 28% below where the index closed Monday - a potentially unfavorable outcome for investors who have piled into the recent bounce.

The bank’s research also shows that longer recessions tend to produce longer bear markets - another worrying sign for a rally that has taken the S&P within 10% of its all-time high with little evidence of a recovery in sight.

The belief that policymakers will backstop markets may be creating a bubble that is pushing investors to buy stocks “despite their better judgment,” said Benjamin Bowler, global head of equity derivatives research for Bank of America Merrill Lynch.

“That sets stocks up for an even more violent correction, because you have a lot of people with no conviction in the trades they are in,” he said.

A Société Générale study examining bear markets over the last 150 years shows gains in past bounces off a bottom have been slower, with the S&P notching an average of 11% in the first three months after drops of 30% or more. After two years, the average gain from the bottom stood around 40% - roughly what the index has gained since late March.

Such rebounds have also featured strong economically-sensitive cyclical stocks, which have struggled to mount a consistent rally this time around, the bank said.

Many market participants, however, argue that the unprecedented level of support by policymakers may produce a reaction inconsistent with previous market recoveries.

A Reuters poll of nearly 50 market strategists and fund managers in late May showed the S&P ending the year at 2,950, just below current levels.

The Fed “had to focus investors to look past the current numbers ... otherwise it would have taken years for the S&P to get back to 3,000,” said Andrew Brenner, head of international fixed income at NatAlliance Securities, in a note.

Some technical analysis also paints a brighter picture. The rally has lifted the S&P 500 above its 200-day moving average and more than 90% of the index’s stocks now trade above their respective 50-day moving averages, said Andrew Thrasher, portfolio manager at Financial Enhancement Group.

“We haven’t seen this level of internal strength by individual stocks until after major downturns ended,” he said.

But investors remain cautious: options on the S&P 500 show traders assigning a 29% probability that the index will fall 10% or more in the next three months, compared with a 12% probability for an advance of 10% or more.

  • Facebook.
  • Twitter.
  • LinkedIn.
  • Print

For more news you can use to help guide your financial life, visit our Insights page.


© Reuters 2020. All rights reserved. Republication or redistribution of Reuters content, including by caching, framing or similar means, is expressly prohibited without the prior written consent of Reuters. Reuters and the Reuters sphere logo are registered trademarks and trademarks of the Reuters group of companies around the world.
Votes are submitted voluntarily by individuals and reflect their own opinion of the article's helpfulness. A percentage value for helpfulness will display once a sufficient number of votes have been submitted.
close
Please enter a valid e-mail address
Please enter a valid e-mail address
Important legal information about the e-mail you will be sending. By using this service, you agree to input your real e-mail address and only send it to people you know. It is a violation of law in some jurisdictions to falsely identify yourself in an e-mail. All information you provide will be used by Fidelity solely for the purpose of sending the e-mail on your behalf.The subject line of the e-mail you send will be "Fidelity.com: "

Your e-mail has been sent.
close

Your e-mail has been sent.

You May Also Like...

Top 5 investing articles of the week

Our editors compiled the five most-popular investing articles of the week. This selection of reader favories delivers investment strategies, market analysis and stock recommendations from leading news sources.

Investing amid the resurgence of coronavirus

John Normand of JPMorgan says investors are right to see the resurgence in coronavirus infections as a risk factor, but advises against turning defensive or negative on markets.

How to boost your Social Security payments

Workers who familiarize themselves with the Social Security rules will be better able to maximize their payments. Here are 10 rules about the program that all workers should know.