The worst is not yet behind us


The American stock market reborn

It was an amazing week for American stocks. After showing signs of exhaustion last week, the S&P 500 index jumped + 7% on Monday, then added another five percentage points to its earnings over the remainder of the shortened vacation week. With US stocks now rebounding more than + 27% in the last thirteen trading days since the lows of March 23, many investors are now wondering if the worst is now behind us.

Impressive resilience

Let’s start by looking at where we are today with the US stock market. The S&P 500 has now retraced 50% of its -35% drop from February 19 to March 23. It is still -18% below its February peaks. And this 50% retracement places it against its last resistance level at 2,792.69. It should be noted that relative strength and momentum are currently in favor of the S&P 500 index advancing above this short-term resistance, especially as stocks have spent much of the trading day Thursday above this key level.

Challenges ahead

Instead, the greater resistance to the current rebound in the S&P 500 is coming. This includes three key levels – the 50-day moving average currently at 2,909 and down, the 200-day moving average at 3,015 and down, and the 400-day moving average at 2,896 and down. It is how US stocks will react in the coming weeks if and when the S&P 500 reaches these key resistance levels that will determine whether the worst is now behind us or the worst is to come.

The importance of resistance

Why should we take care to monitor these resistance levels? Because they have proven to be very important early warning signals in the past of what was yet to come.


At the end of 2007, the American stock market fell into correction. After peaking on October 9, 2007, the S&P 500 fell -20% until mid-January 2008. It then rebounded by + 10% until February 2008. But by the time it reached its moving average from 50 days on a downward slope, it fell sharply. back as Bear Stearns began its final descent towards its March 2008 collapse. After the Fed’s rescue of Bear Stearns was resolved in mid-March, the stock market appeared at its lowest and the rally was on the move, as it looked like the worst was now behind investors at the time. The S&P 500 index then rebounded by + 15% until mid-May 2008. But once it reached its 200-day moving average on a downward slope which included an intraday variation to its 400-day moving average , the game was officially over for US stocks, as we all know what went on from there until March 2009. It should be noted that the peak in May 2008 and the subsequent failure also occurred when Fibonacci’s 50% retracement of the S&P 500 index from its peaks in October 2007 to its lows in March 2008.


Let’s go back to 2000 for another example of the importance of monitoring these key resistance levels. Although history books note March 2000 as the peak of the technology bubble, it wasn’t until September 2000 that the US stock market really started to crash. From the beginning of September to mid-October, the S&P 500 index dropped by -15% before recovering thereafter. Stocks then rebounded + 10% until early November before returning to their 50- and 200-day moving averages. The S&P 500 continued to fail twice more than its increasingly tilted 50-day moving average in early December 2000 and early January 2001 before finally breaking this barrier in mid-January, and finally fail at its moving average of 400 days.

So when we are looking to determine if we are destined to go further down in a bear market in the next few months or if US stocks are about to quickly put this staggering month-long correction behind us, it is very instructive to closely monitor the reaction of actions to these keys. shift average resistance levels over the next few months.

If stocks fail at these levels, it would mean the worst is yet to come for US stocks, just as it was in early 2001, early 2008, as well as June 2010, August 2011, December 2016 and November 2018 during some of the most notable corrections after the crisis.

Conversely, if stocks crossed these resistance levels as they did in spring 2003, summer / fall 2009, as well as in September 2010, January 2012, March 2016 and early 2019 during the period of after the crisis, this would indicate that the worst is now behind us.

At a minimum, investors should carefully consider recomposing at least part of their risk profile each time they reach these key resistance levels. This is especially true for those who may have been overweight in high-risk stocks and securities before this crisis. Because if the market falls, you will have protected capital. And if stocks are definitely going up, there is always an opportunity to reinvest.

And the fundamentals?

This is where things get cloudy. The underlying market fundamentals are unequivocally poor. Global economic growth has effectively stopped, unemployment is skyrocketing, corporate profits are expected to evaporate at a time when stocks are still sharply overvalued on the basis of historic profits, even after the recent market correction, and the prospects for the future are about as uncertain as it could be not only vast economic, but also health and societal unknowns given where we are today.

Frankly, the recent stock market rebound since March 23 defies all fundamental logic. This is not surprising, however, as stocks have historically always rebounded strongly after steep declines, even in the worst of bear markets. But the rebound is not fundamentally driven significantly.

Now, some are countering this fundamental conclusion by proclaiming that the US stock market is a predictive mechanism that predicts the state of the economy nine months in advance. There was a time when I would have accepted this statement, but it is deeply flawed in my opinion today. Why? For example, if the US stock market was such a good predictor, why didn’t it go down nine months ago instead of falling back like a house of cards from early February? And if the US stock market was such a reliable predictor, why has it repeatedly overestimated the strength of economic growth year after year after year during the post-crisis period?

Instead, the main predictive objective that the US stock market serves today, in my opinion, is whether or not the US Federal Reserve will succeed in providing sufficient monetary policy support to keep the stock market artificially inflated after the crisis for a few more cycles.

This brings us to some important points for investors to consider as we progress through this unknown piece of news in the weeks and months to come.

Know what feeds the bull

If you are an investor, you simply cannot fool yourself. The stock market has rebounded so strongly since March 23 thanks to the actions of the US Federal Reserve. If the Fed had not intervened with extraordinary policy measures, many of which would have been completely unthinkable just two months ago, the US stock market and its many other highly correlated risk assets would almost certainly have continued to plunge steadily and sharply down. So if you’re optimistic, it’s important to resist the urge to think that any further gain in short-term stock prices is based even on the basics from a distance. Maybe they will be eventually, but they certainly are not now and will not be in the foreseeable future, as we simply have no idea what these fundamentals will actually look like in the months to come .

Your savior is also your bane

The Fed will stop at nothing to save the economy and its financial markets. What they deploy in 2020 are exponential orders of magnitude greater than what they deployed during the 2008 financial crisis, which were exponential orders of magnitude greater than the standard interest rate cuts deployed during of the bursting of the technological bubble. Do you remember the Fed’s rescue of long-term capital management in 1998? It seems so picturesque in comparison 22 years later. We have a trend here. Basically, the Fed seems to keep making things worse with each successive “rescue”.

Given all of this, it is reasonable to wonder if today’s plight would have been easier to deal with if the Fed had pulled back a bit and stopped trying to micromanage the economy and the markets. At this point, why exactly did the Fed have to intervene so aggressively and so quickly to save almost everything in the financial markets in just a few days after realizing that COVID-19 was going to become a major problem for the global economy? Because they have fostered a market environment for so many years that has encouraged extreme valuations, unsustainably tight credit spreads, too much leverage, excessive risk taking and, unfortunately, insufficient preparation for future operational challenges, while assuming that the Fed would simply be there to save the day at the first sign of trouble. For example, if the Fed had simply backed down once it stabilized the financial system in 2010 and returned to a supervisory role instead of trying in vain to stimulate sustained economic expansion, we might have had more reasonable valuations, more reasonable spreads, less leverage, more prudent risk-taking and companies better prepared for a rainy economic day. Unfortunately, we will never know. I hope we will finally learn for the future, but I have doubts.

“Our emergency measures are reserved for really rare circumstances such as those we face today. . . When the economy is well on its way to recovery and private markets and institutions are once again able to perform their vital functions of channeling credit and supporting economic growth, we will set aside these tools of emergency. “

–Fed Chair Jerome Powell, April 9, 2020

The genie is out of the bottle

The Fed could pretend that these are emergency measures that will be canceled once the economy has returned to recovery. But let’s be real. It is not going to happen. Large-scale asset purchases in the form of quantitative easing were emergency measures that were also reserved for really rare circumstances such as those we encountered during the financial crisis. And despite the fact that the economy was well on its way to recovery, and that markets and private institutions were once again able to perform their vital functions of channeling credit and supporting economic growth, these tools not only have they never disappeared, they have been redeployed more aggressively in the future. In short, what used to be emergency measures has become an expected policy that was quickly demanded by the market as a petulant child. Tools perpetually out.

In the wake of the COVID-19 crisis with OPEC + gasoline thrown on fire, the Fed is now involved in the purchase of everything that lacks stocks (at least for now, especially if the worst is come in the next few months). Now that these tools are out, count on the fact that they will remain forever. Or at least until a major political accident has occurred.

The Law of Unintended Consequences

We were already in unknown territory with the financial markets during the post-crisis period. In the wake of COVID-19, we are now at the other end of the universe. The Fed fired all of its monetary policy guns at once to save the global economy. And with each passing day, they seem to be pulling a new trick from their sleeves, including the announcement today that they are now going to buy high-yield bonds (I guess I am making selected and targeted accommodations for the recent ” Fallen Angels “who are the main US employers like Ford Motor (NYSE: F) – these are extraordinary moments, after all – but the long iShares iBoxx $ High Yield Corporate Bond ETF (NYSEARCA: HYG), really? It’s just one more step down the slippery slope of the Fed being long Tesla (NASDAQ: TSLA) one day).

But by acting brutally in an emergency and throwing everything and anything into a problem, this can lead to two key challenges that we, investors, must soon carefully consider.

First, what happens if the Fed’s actions don’t work? They solve the liquidity problem facing the economy and the financial markets. But what if their purchase demand is not sufficient over time to compensate for the demand for sale on the private market. Of course, this has always been the problem during QE1, 2 and 3, as more investors were selling T-bills than the amount the Fed bought, which resulted in higher treasury returns during these programs, no less. I understand they can always do more. But even if they did more, solving the liquidity problem and tackling the supply side of the equation still doesn’t solve the problem of default risk and the demand side. At this point, it’s great that the Fed buys every prominent bond that meets its stated but flexible criteria, but if consumers don’t spend and businesses are unable to pay the interest and principal on their debt, so a the default is always a default, regardless of who is holding the bag.

Second and perhaps more importantly, what if the Fed finally loses credibility? A “mystery” to the Fed throughout the period following the financial crisis was the reason why their political actions never led to a sustained rise in inflation that could maintain their target. But what if in the process of rejecting everything during the COVID-19 crisis, the Fed unintentionally unlocks the blocks that prevented a persistent surge in inflation over the past decade. After all, if they could not understand why inflationary pressures never built up, they probably did not know where the bottlenecks that needed to be eliminated existed. Or what if all the extreme impression of money ultimately causes a loss of confidence in the fiat money system of the past half century. Only time will tell, but we will move it forward.

The only thing we know for sure, however, is that if we start to see a sustained increase in inflation, the Fed will let it warm up for quite a while because they will finally get what they have been looking for if long time. Unfortunately, this has the potential to lead to rampant inflation before all is said and done, particularly if we find ourselves in a demand-driven situation where too much money is running out of goods at the same time. time, we still have a cost surge the economy is adapting to a post-COVID-19 world. The Fed would then be forced to brake on the brakes on monetary policy, and this is where things could get really difficult.

These are two risks that we must carefully consider following the response of the COVID-19 rescue policy as we move forward.

Known unknowns

The world has changed dramatically in the past two months. And we’re probably at the start of what should be a series of changes and adjustments underway over the next few quarters and years. Just as the post-financial crisis period was significantly different from the previous one, the post-COVID-19 period will also be very different in the future. It will be important that we work to determine in the days and weeks to come whether the worst is now behind us or to come to begin also to think about how we will have to adapt our risk management process and meet expectations in a post-COVID-19 world. This is a discovery process that will require continued attention as it will evolve and evolve over time.

In the meantime, use the information you have. The key technical resistance is straight for the S&P 500 index. How it reacts to these resistance levels will go a long way to indicating the direction of financial assets in the coming months.

As for whether the worst is now behind us, I would say that, unfortunately, we are just getting started.

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Disclosure: I have / we have no positions in the stocks mentioned, and we do not intend to take any positions in the next 72 hours. I wrote this article myself and it expresses my own opinions. I do not receive any compensation for this (other than from Seeking Alpha). I have no business relationship with a company whose actions are mentioned in this article.

Additional disclosure: I have long been selecting individual stocks as part of a broad asset allocation strategy.


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