You are probably wondering why the stock market has had any rallies at all, let alone ones this big, considering how bad things are looking. And obviously no one can tell exactly where the market should/shouldn’t be. Nothing really makes sense now. But here are just some things to consider.
First, the stock market didn’t drop JUST directly because of Coronavirus infection count / death count expectations, and expectations of bad earnings.
There were several combined factors that stacked on top of each other, kind of like a chain reaction. (This isn’t an exhaustive list)
Easily Predicted / Expected Results:
- People greatly reducing spending and staying in
- Much Less Revenue for Companies
- Drop in oil prices / Energy usage
- Some kind of stimulus
- Poorly situated companies going bust
Not So Expected / Surprises:
- Saudi / Russia oil fight
- Extreme stress in credit market / corporate bonds
- Liquidity crisis
- Western world being effectively forced to stay home
- The fact that all this happened so swiftly at once
I’m NOT saying we have / haven’t already reached the bottom. BUT, I will say, I think the initial drop was so big and so fast, not because of the virus, but because of all the “surprise” factors. And a lot of these issues are being, or have been solved.
- Saudi Arabia and Russia reached an oil deal
- The Fed pumped massive liquidity into the market, and bought not just investment grade, but junk corporate bonds (notice how the ‘bottom’ was the day the Fed announced the massive liquidity injection)
- We are at least talking about returning to work, even if behavior will be different for a long time
So my point is, yes, the market could go down further over the next year. However, I believe this recent rally is because we have at least solved the current major unexpected surprises. All of these things were causing increased uncertainty, which couldn’t be priced in, so everyone just sold everything. The market is always forward looking, and people know this isn’t going to last forever. It can price in bad or even terrible earnings, but it can’t price in what it doesn’t know, and I think this recent situation was a rare instance where everyone knows just how much they don’t know, and that caused a huge spook in the market. With so much uncertainty being relieved, we’re basically just having to deal with how bad earnings will be going forward, but not all the other stuff (of course, there could still be surprises).
Bear Case: The market isn’t saying that’s the bottom, just that it was too premature before the shit really hits the fan. We’ll see more negative surprises and this will last longer than people think. Everything was already overpriced, so we have further to go.
Bull Case: We’re still far down from the top despite the rally, and with so much liquidity, when we eventually get out of this, companies they will have even more firepower and cheap money to borrow to grow, possibly being in an even better position for the ones that survive.
TL;DR: I think the rally from the bottom is not because the market believes everything is fine now, but rather because it is adjusting to reduced levels of current uncertainty.
Disclaimer: This information is only for educational purposes. Do not make any investment decisions based on the information in this article. Do you own due diligence.