U.S. Equity Markets Stubbornly Ignore the Doom Everywhere

(Bloomberg Businessweek) -- The bearish case for the U.S. stock market is so obvious, it can be hard to believe that there’s any argument—let alone that bulls have often been winning it in the past few weeks. The U.S. economy is in the throes of such a deep economic downturn, with 36 million unemployment claims filed in the past eight weeks, that the word “depression” is being thrown around increasingly casually. A period of deflation is upon us, with the core measure of consumer prices declining in April by the most on record in a sign of the stresses many companies are facing in a locked-down world.

Hopes for a quick—or V-shaped—recovery are fading as reality sinks in that reopening the economy won’t necessarily cause consumer behavior to revert to its old form as long as Covid-19 continues raging through the country, killing an average of more than 1,400 Americans a day in the week ended May 16. Only a few major companies now expect a V-shaped rebound, according to Goldman Sach Group Inc.’s review of the first-quarter earnings season. Most managers now expect the economic charts to look more like the letter “U” or “L,” meaning the recovery will be slower and more gradual than optimists believed at the beginning of the crisis. About 180 of the companies on the S&P 500 pulled earnings guidance during the period, the Goldman report showed.

Cautious comments from respected voices are piling up. Federal Reserve Chair Jerome Powell triggered a bout of selling on May 13 by warning of an extended period of economic weakness subject to “significant downside risks” and pushed back on the notion that the central bank would take its benchmark rate negative to stimulate the economy. He’s urging Congress to spend more to stem the economic fallout. And, with campaign season about to get into full swing, Congress appears to have lost the sense of urgency that fostered a rare moment of bipartisanship early in the crisis to pass stimulus. Even the ghost of market volatility past—trade tensions between the U.S. and China—has returned to the scene as President Trump seeks revenge for the damage done by a virus that started in China.

And yet, despite this apparent slam-dunk case for a bear market, U.S. equities refuse to cooperate. The S&P 500 index is down less than 10% so far this year, with about a fifth of its stocks higher in 2020. The Nasdaq 100, dominated by the biggest internet and biotech stocks that are serving as a haven in this turmoil, is actually up.

What could possibly be keeping investors from losing their cool? For one thing, Wall Street loves a good acronym, and one that’s popular these days is the old standby TINA—short for “there is no alternative” to stocks. TINA’s back in town with interest rates on ultra-safe Treasuries dancing closer to 0% than they’ve ever been. In theory, that can make some investors willing to pay higher valuations for stocks. Even if the likely returns at today’s prices—and with today’s risks—look low, in the eyes of many investors they still beat almost-zero. That’s especially true for pension and fund managers, who have to hunt for return somewhere.

Another obvious explanation is what Bloomberg Opinion’s Noah Smith dubbed “the Golden Put,” a reference to a type of options contract that protects investors against losses. The provider of this put is the Federal Reserve, Congress, and President Trump, who, the thinking goes, will do whatever it takes to continue to mitigate the economic damage and, in doing so, keep the equity market afloat.

That Golden Put may be tested as partisan fighting returns to Congress, with House Democrats’ latest $3 trillion stimulus package pronounced dead on arrival by the president and Senate Republicans. And while the Fed theoretically holds a checkbook filled with blank checks, some question if its efforts will be enough to keep equities buoyant, absent the once-unthinkable notion that the central bank would purchase equities outright. (It’s thinkable: Japan did it years ago.)

“Whatever the Fed is doing here is not going to increase a company’s cash flow that is needed to meet their obligations,” says Peter Boockvar, chief investment officer of Bleakley Financial Group. “They can’t print earnings needed to pay interest expenses. They can’t print jobs. They can’t create antivirals and a vaccine and get people confident to shop without risk until then.” 

One more theory: Many of the big companies that already dominated the S&P 500 before Covid-19 were ahead of the curve in building businesses that don’t rely as much on people and are well positioned to survive social distancing. “A lot of the productivity investments that companies made over time have allowed the absorption of this shock of the elimination of a tremendous amount of face-to-face work,” Joseph Fuller, professor of management practice at Harvard Business School, told Bloomberg News. 

Still, a chorus of some of the most respected investors in modern history, including Bill Miller, Paul Singer, Paul Tudor Jones, Stan Druckenmiller, and David Tepper, have expressed doubt about the durability of the rebound in stocks. The widespread skepticism can be seen not just in the talk but in the few real-time glimpses of hedge fund positions available. Net bets on a drop in S&P 500 e-mini futures contracts, the favored tool of big-money professional investors, are near records highs in notional dollar terms. 

And yet despite all the drama, the S&P 500—that ever-important proxy for so many Americans’ retirement savings—has basically gone nowhere since early April. Markets seem a little stuck: They don’t have clear enough information about how bad things are, or about when things might get better, to make the next move. 

Perhaps it’s a sign of the confusing times that lately many traders are looking for guidance from an even older market influencer than the Fed: the Italian mathematician Leonardo of Pisa, also known as Fibonacci, whose work is more than 800 years old. Fibonacci turned Western mathematicians on to sequences of numbers described in ancient Indian texts. These numbers have an uncanny way of appearing in natural settings, such as the way leaves grown on a stem, and are integral in some fundamental computer-programming algorithms. Some traders think patterns he spotted can be used to develop trading signals.

Traditional fundamental investors who study valuation measures based on profits and cash flows roll their eyes at this. But perhaps it’s natural that, with the fundamental outlook so hazy and uncertain, traders are taking comfort from lines on a chart representing mathematical absolutes. And if enough people and computerized traders do it, that itself can be self-reinforcing. Looking at a chart of the S&P 500 this year, it’s unmistakable that since early April the index has been pinned almost the entire time between two of what are known as Fibonacci retracement levels, representing where the market recouped 50% and 61.8% of its losses in a lightning fast crash from a February record.

A simpler way to put it is that investors, like everyone else, are having a lot of feelings right now—and that’s what’s driving the market day to day until clearer news arrives. “Fib levels are a representation of human nature,”  says J.C. O’Hara, chief market technician at trading and research firm MKM Partners. “Reversals from extremes historically retrace by a certain percentage. Why? Because the market is governed by human emotion, and that generates waves of fear and greed. That form is repetitive and thus predictive.” 

Another thing that’s easily predictable is that trading ranges like this don’t last forever. The current one that’s defined the S&P 500 for a month and a half, whether because of the legacy of some 13th century math genius or just a random walk down Wall Street, is going to end one day. On Monday euphoria over positive results from tests of a coronavirus vaccine sent the S&P 500 slightly above the upper Fibonacci level, at least before the close. Still, in a best-case scenario it will be several months before a vaccine is widely available, and it's possible the economic situation will only get murkier in the meantime. Investors need to think long and hard about what the view could look like after the informational fog lifts.  —With Sarah Ponczek  

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