MARKET OBSERVER – N° 133

Compared to the lows in the second half of March, the S&P 500 index of the US stock exchange retraced 50% from the historical high of February. According to technical analysis, the extent of this bounce satisfies what the Pisan mathematician, Fibonacci, theorized several centuries ago, confirming the validity of this type of analysis even after a paroxysmal market phase, which could have done significant damage to the reliability of the technical approach.

Further analysis now indicates an important support area in the 2700 / 2730 range, which, if it holds, would indicate an upward move to between 2700 and 2900, which is the accumulation range where a base could form from which to subsequently develop a normalized trend. The hypothesis of a new, renewed bearish phase that could bring the index near the lows of March would therefore fade away. Notwithstanding that only staying above the indicated levels would refute this thesis, it is a matter of finding an explanation that allows us to understand how the world’s most important stock exchange has limited the damage to 20% from the highs when economists’ estimates are revised downwards on a daily basis, indicating real GDP contractions across the globe, in the order of 6% up to 12% for the current year. During the Great Financial Crisis of 2008 (GFC1), world GDP contracted by about 5% and the S&P 500 index at its low was worth 9 times trailing earnings, while now it is worth 19 times the earnings of the last 12 months. Certainly the 2700 level in the short term could be broken to the downside, but even in this case, technical analysts hypothesize a higher low of 2550 points, since the marked rally renders unlikely the previous more pessimistic hypotheses. In fact, the big difference compared to what happened in the aftermath of GFC1 is found in the response of governments in terms of fiscal policy and central banks in the measure of monetary stimulus interventions.

To deal with the serious consequences of the production shutdowns implemented to limit the contagion of Covid-19, instead of adopting fiscal austerity measures accompanied by zero cost of money, as in the case of GFC1, an intervention by the Central Banks (QE4) of massive size, which led their aggregate balance sheets to exceed 20 trillion dollars, without the Chinese PBOC, however, having contributed in any way. Even the fiscal measures implemented by the various governments are currently worth 6.5% of global GDP, therefore another 6.5 trillion dollars, much higher than the amount in 2008. Taking into account an average multiplier of 7 for the contribution of QE4, global liquidity can be estimated to have increased by around 45 trillion, now worth 200% of world GDP. Therefore, this seems to be the factor that has allowed all the world stock exchange indices to quickly recover a part of their losses, taking for granted the fact that this huge mass of liquidity will allow the various economies to return to a normalized economic cycle in less time than was foreseen in mid-March. It should be noted that this eventuality is very likely for the US economy, likely for the Asian economies, in particular for the Chinese economy which, as noted, has not yet implemented its QE4, while in Europe monetary stimuli have been decided but persistent obstacles remain on the fiscal policy front, which risk penalizing the recovery potential of the indices of the Old Continent. It is clear that this excess liquidity initially favors the stock markets and then will be absorbed by the real economy, where it will cause the end of the long deflationary phase exacerbated by the current crisis, which will give way to an inflationary resurgence in 2021, as evidenced by the strong global demand for physical gold.

Nicola Bravetti Data Source Bloomberg
P.S.: editorial close at 17:00; April 20, 2020

“This report cannot – nor can – be considered a solicitation to invest in financial instruments”