MARKET OBSERVER – N° 135

The month of June started in the best possible way, given that the first week ended with the US S&P 500 index closing marginally up for the year, in essence eliminating the annual loss recorded since March 19.

The other important world equity indices also followed the positive trend of Wall Street, above all in China, given that since the beginning of the year they have recorded a modest percentage increase. So, on a superficial examination, it might seem unreasonable that the stock market valuations have already totally left behind the serious economic consequences of the measures implemented to contain the contagion. An explanation to understand this sudden recovery towards pre-crisis levels, could be traced back to the enormity of the monetary and fiscal policy measures implemented by the competent authorities in the short span of a few weeks, quantifiable in an overall figure of about 20 trillion dollars, equal to more than 20% of the world’s annual GDP.

In this regard, it should be noted that already in the aftermath of the previous great financial crisis (GFC1) of 2008/09, the periodic phases of monetary stimulus that followed in the following decade up to the present day (QE) have contributed to creating a phenomenon on the stock exchange previously unknown technical phenomenon, that of the “flash crash”. Which we started to see with some frequency, to sudden drops of the main indices, quantifiable in losses on a daily basis at times close to 10 percent, which were then retraced in an extremely short time span, from a few sessions to a few weeks. This is clearly a technical consequence of the enormous liquidity introduced into the international financial markets, which finding only a modest outlet into the real economy, mainly pours into the securities markets, accentuating their volatility out of all proportion. Similarly, it could be assumed that we are in the presence of a “flash” recession, practically in a marked, but unusually short economic downturn, of six / nine months instead of the usual twelve to eighteen months. Developing this thesis, it could be argued that the stock market indices, which by their nature discount future economic prospects, (it is no coincidence that the stock market index is one of the components of the US precursor super-index, consisting of 20 parameters that should give an indication of future economic trends), is correctly discounting a strong recovery in the economy starting from autumn.

The surprising unemployment data in May, both in the United States and Canada, published last Friday, seems to support this thesis. To further confirm this working hypothesis, we can also consider the atypical origin of the current recession, in the sense that it did not come from endogenous factors to the economy as in traditional case studies, but the catalyst of the same was an element exogenous to the system, which has appeared as suddenly as it is now gradually disappearing. For want of an analogy, the economy is like a car that traveled on an open road and suddenly found itself in front of an obstacle; the virus. Standing still with the engine running, the car consumed gasoline, but once the obstacle was removed, just add more gas, liquidity, and resume the journey from where it was interrupted, only having to make up for lost time. So, in the case of the restart from the mini recession of 2020, the recovery will be very rapid, justifying the positive trend that the stock markets have telegraphed since the end of March without interruption.

The levels reached by the various indices are compatible with the imminent start of a phase of lateral consolidation, aimed at absorbing the short-term overbought levels. Mainly via a sector rotation of stocks, rather than with a marked correction, limited, in the case of the S&P 500 at 2950 points. So the more defensive sectors rather than growth stocks, which have guided the indices in the recent rise, appear destined to give way to the traditionally cyclical, industrial and chemical sectors, and to those that suffered the most during the correction, such as luxury goods, oil, transportation, automotive and tourism. The financial sector does not appear interesting, as the general flattening of the yield curve and the inevitable increase in bad debts limits its potential, with the only relevant exception being that of the US banking sector, given that consolidated dollar yields could increase and a strong rebound of merger and acquisition activity is expected.

Nicola Bravetti Data Source: Bloomberg

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