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Is There A Dislocation?

June 3, 2020

There is a heavyweight bout going on between investor euphoria supported by economic stimulus packages and the combination of historically massive U.S. jobless claims, China-Hong Kong-India tensions, & now renewed U.S. – China turmoil. So far, the bullish euphoria is winning.

In May, we witnessed some nice follow through for stocks following April’s record setting gains when stocks had their best month in 30 years.   All the major U.S. equity indices were positive for the month of May, and developed world international stocks also kept pace.  Emerging Market stocks were up slightly although the clear laggards for the month.

Financial media has been posing a question for the past couple of weeks:  Is there is disconnect between the stock market and the economy?  Many argue that there is a dislocation between market price action and the economic outlook.  As reported by BNN Bloomberg, many CEOs of financial firms have warned stock market gains are overly optimistic. These include CEOs such as Citigroup’s Michal Corbat, Blackrock’s Larry Fink, as well as JPMorgan Chase CEO Jamie Dimon, who noted that recent stimulus must be wound down at some point and stated, “you can’t prop up the stock market forever.” 1

As we discussed last month, economic data--in many cases-- is as bad as we have seen in our lifetimes. In the first quarter, the U.S. economy shrank faster than estimated with Gross Domestic Product (GDP) falling at a 5% annual rate, the biggest quarterly contraction since 2008.  The COVID lockdown did not begin until March, so second quarter GDP estimates are worse.

U.S. consumer spending, which accounts for about two-thirds of the world’s largest economy plunged 13.6% in April,  the most on record.2 According to CNBC, over 40 million people have filed for unemployment since the COVID crisis began.3  Continuing U.S. jobless claims remain at the highest point in the history of the economic indicator.   However, major U.S. stock indices are each 35 to 40% higher than they were on March 23rd.

For some perspective, let’s look at where stocks are trading currently in relation to where they were prior to the lockdown and prior to the COVID crisis in general.  The tech heavy NASDAQ Composite index closed May at the same index level it was at on February 21st, weeks before the U.S. lockdown was in effect.  That is also where this index was trading at on February 1st well before the market peak on the 19th of that month when unemployment was at or near an all-time low. At that time we were seeing consistent GDP expansion, and the outlook for corporate earnings was very optimistic. 

Likewise, the S&P 500 index is the highest it has been since March 5th prior to the US lockdown.  This index is at the same level it was in late October of 2019 when the economic picture was very rosy. This poses a question.  Are we in as good of shape now as we were then?  The market is telling us yes, but the economic data is showing a different picture.  Clearly, the U.S. debt level has increased substantially due to the increased crisis stimulus.  So, what does that mean for the future?   

WHAT NOW?

Quite simply, we must wait and see how this heavy weight bout plays out.  It’s possible this one could go the full 15 rounds before we have a clear winner.

TECHNICALLY SPEAKING

The rapid rally in stocks has our short term technical model in bullish territory. Despite the technical damage that was inflicted by the rapid bear market declines in late February, and most of March, our long-term technical readings are moving into positive territory along with the continued positive price action we witnessed in May.  It is encouraging to see the strong relative performance of small cap stocks, which is generally a good indication that investors are willing to take on more risk. 

That in turn is typically a positive sign for the markets in general because that type of speculation is needed to drive stock prices higher. Since April 4th the Russell 2000 small cap index has outperformed the S&P 500 by 10.04% demonstrating that favorable relative strength.  For now, our models are calling for a moderate allocation to risk assets. However, with indications still near their signal lines that can change quickly so we will be watching closely.

1 https://www.bnnbloomberg.ca/finance-ceos-worry-markets-are-too-optimistic-about-economy-1.1442246

2 https://www.bloomberg.com/news/articles/2020-05-29/u-s-consumer-spending-plunges-jobless-benefits-boost-incomes?sref=G1Raqkno

3 https://www.cnbc.com/2020/05/28/jobs-data-shows-millions-went-back-to-work-but-unemployment-rate-for-may-is-still-expected-at-20percent.html

Gross Domestic Product (GDP) is the monetary value of all the finished goods and services produced within a country's borders in a specific time period.

The S&P 500 Index is the Standard & Poor’s Composite Index of 500 stocks and is a widely recognized, unmanaged index of common stock prices.

The NASDAQ Composite is a stock market index of the common stocks and similar securities listed on the NASDAQ stock market and it is highly followed in the U.S. as an indicator of the performance of stocks of technology companies and growth companies.

The Russell 2000 Index is a small-cap stock market index of the smallest 2,000 stocks in the Russell 3000 Index.

There are certain limitations to technical analysis research, such as the calculation results being impacted by changes in security price during periods of market volatility. Technical measurements are one of many indicators that may be used to analyze market data for investing purposes and should not be considered a guaranteed prediction of market activity.

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