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Optimism Prevailed Last Week, but Have US Stocks Moved Too Far, Too Fast?

James Hyerczyk

The major U.S. stock indexes finished higher last week on optimism over the reopening of the states’ economies and some positive developments in the quest to find a vaccine for coronavirus. That was in the beginning of the week. Later in the week, prices retreated as caution returned due to geopolitical tensions as China announced a plan to impose a new security law on Hong Kong and as a U.S. Senate bill was introduced that could force Chinese firms to delist from U.S. exchanges.

Over the short-run, it looks as if these issues are going to be a source of volatility, but longer-term, the huge government fiscal and Federal Reserve monetary stimulus packages should help investors weather the storm. However, traders do face headwinds due to simmering U.S.-China relations that could lead to a new “Cold War”. Furthermore, there is also the possibility of a second-wave of coronavirus cases that would wreak havoc on the already devastated economy.

Last week, the benchmark S&P 500 Index settled at 2955.45, up 91.75 or +3.20%. The blue chip Dow Jones Industrial Average finished at 24465.16, up 779.74 or +3.29% and the technology-based NASDAQ Composite closed at 9324.59, up 310.03 or +3.44%.

The World Has Changed Just Three Months Since the All-Time Highs Were Reached

The world is very different now, and the key fundamental conditions investors were watching in February have changed. At that time, investors were worried about whether the economy could stand to continue to add upwards of 200K new jobs each month to sustain the longest expansion in history.

Some experts saw the economy as “too hot”, but no one foresaw a global pandemic and ensuing unprecedented health-crisis-driven recession. Just like no one predicted the markets would turn from bull to bear in a matter of weeks, no one forecast solid week after week gains of more-than-30% over the past two months. This move has prompted the analysts at Morningstar Direct to call the rally since March 23, the strongest “bear-market rally” in the last 75 years and the sharpest two-month gain for the S&P 500 since before 1990.

Looking Ahead …

This weekend, the analysts at Edward Jones asked the question:  Has the market come too, too fast? Here are their three takeaways to consider:

This rally is based on the future, not the present.

The stock market is forward-looking. The market sold off in February and March because of the uncertainty around the growing pandemic and anticipation of a resulting recession. Stocks are now rallying on expectations that have leaped forward to the reopening of the economy and a rebound in GDP and corporate profits. Furthermore, the incoming economic data has been somewhat backward-looking.

Recoveries Take Time.

The stock market can and will move faster than the economy, but the two are connected, and over time, the path for the economy sets the foundation for market performance over the broader term.

It took 3.5 years for GDP to recover following the Great Recession of ‘08/’09, corporate profits rebounded more quickly, supporting solid stock market gains in 2009 and 2010.

There is reason to be optimistic while also realistic.

The pendulum of market sentiment has swung decidedly more positive lately. The market is pricing in a somewhat smooth re-opening of the economy. This essentially means that evidence of setbacks or slower progress pose potential risks in the near-term.

While we acknowledge that the size and duration of the current rally has been a pleasant surprise, we don’t expect it to persist at the same pace or magnitude uninterrupted. We anticipate headlines on the coronavirus, economic and earnings data to display a mixture of encouraging green shoots as well as periodic setbacks. This being said, continue to have appropriate and realistic expectations for near-term market swings and longer-term returns.

For a look at all of today’s economic events, check out our economic calendar.

This article was originally posted on FX Empire