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Why stocks rally when things are terrible: Morning Brief

Sam Ro
·Managing Editor
·5 min read
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The stock market rally is not some Wall St. conspiracy

Last week, the stock market had its best week in decades.

This came as we learned another 6.6 million workers filed for unemployment benefits for the first time, bringing the cumulative 3-week tally to 16.7 million. Recent claims data are some of the worst economic data the U.S. economy has ever seen.

The two headlines were juxtaposed during a moment on Jim Cramer’s “Mad Money,” which led to a screengrab that went viral on Twitter.

The contrasting sentiments of the stock market rallying and the economic data tanking were so jarring that everyone from news anchors to politicians found themselves somewhere between dumbfounded and outraged.

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@JustinAHorwitz
@JustinAHorwitz

But there are three things to remember that’ll help make sense of all this.

First, the S&P 500 is still down 18% from its Feb. 19 high. So, the market continues to think the world is in much worse shape than it thought two months ago.

Second, while things remain uncertain, they’re a whole lot less uncertain than they were when large parts of the economy began to shut down to fight the coronavirus. When the restaurants started closing and people stopped going out last month there had not been any promise of aid from the government. Without any emergency policies enacted or signed into law, everyone was supposed to follow the old rules (i.e. pay bills on time or else make cuts and potentially go out of business).

How would policymakers like the Federal Reserve help and when would that help come? Markets seem to be saying that the extraordinary monetary and fiscal policy measures unleashed have been timely.

“When you remove near-term bankruptcy risk from every publicly-held company regardless of credit rating or near-term financial condition, asset prices should rise,” DataTrek Research co-founder Nick Colas wrote on Friday. “Markets know that no matter how bad cash flow might be there is a Fed loan backstop waiting in the wings if needed.”

Third, the stock market is about the direction of expectations. News doesn’t have to be good to move stock prices higher. In fact, you could have great developments, but if expectations were for even greater developments, then you might see stock prices fall. The same logic applies for bad news: if the news is bad but the market was expecting worse, then you may indeed see stock prices rise.

So the market may be reflecting expectations that are less dour than they were just a few weeks ago. Maybe the economic contraction won’t be as deep and protracted as previously expected. Maybe the earnings recession won’t be as terrible as expected. And so on.

“It is, in other words, an unusual time in which we can only hope that stock investors know something that millions of people facing a catastrophic economic situation don’t,“ The NY Times’ Neil Irwin wrote on Friday.

The stock market got crushed in early 2020 before coming back a bit. (Yahoo Finance)
The stock market got crushed in early 2020 before coming back a bit. (Yahoo Finance)

Just because stocks are up doesn’t mean stocks won’t fall again

That said, it has become unusually challenging to know what kinds of expectations are priced into the market because there has been no consensus on what to expect. You can blame that on the unprecedented amount of uncertainty that the coronavirus crisis has caused, which has left forecasters guessing as they fly blind into the investing future.

However, we do know that forecasters have become very bearish very quickly, and at some point we may eventually learn they overcorrected and became too bearish.

“[Y]ou know you are getting closer to a bottom when Wall Street economists are tripping over themselves to see who can have the lowest forecast for Q2,” Renaissance Macro’s Neil Dutta wrote on LinkedIn, coincidentally within a day of the S&P touching its Feb. 23 low.

“It's not a surprise to see markets rally AFTER the most bearish views have been published,” Dutta wrote for Business Insider on Wednesday, adding “it's probably underappreciated and certainly undercovered, the extent to which the government is plugging a very deep hole. That does not absolve them of additional action, and hardly implies markets are out of the woods but does make it likely that worst case recovery scenarios are avoided.”

“Likely,” is a key word here. As Oaktree Capital’s Howard Marks wrote recently, “... there’s simply no room for certainty in investing, and today more so than usual.”

So, while it’s quite possible that the market has bottomed (see here and here), it’s far too early to have a high degree of confidence that the market has it right.

Uncertainty could explode again, expectations could collapse again, and the market rally everyone was complaining about could become a forgotten memory in what becomes a protracted bear market.

By Sam Ro, managing editor. Follow him at @SamRo

What to watch today

There are no major economic data releases and earnings reports scheduled for today but the coronavirus will remain a focal point among investors.

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