This Key Chart explains the Rout in the US Stock Market and Should Explain Rebound too

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US stock market futures have bounced off today after historical rout on Monday. The rally seems to be purely technically driven, a typical respite which often follows heavy selloffs. It’s still too early to call for the end of sales, given that even the “tireless optimist” Trump hinted at the possibility of a recession. Large US banks forecast negative GDP growth in the US in the second quarter. The likelihood of a fiscal response from the government (i.e. increase in government spending) is rising due to the fact that the Fed lowered the rate to almost 0. This will allow the US government to more safely and aggressively increase debt to finance expenditures.

Goldman and other US banks are now issuing disappointing forecasts for the second quarter due to the devastating effect of partial isolation of the United States and local quarantines on the US economy. It is obvious that quarantine and all kinds of restrictions are a function of the progression of the infection, therefore the growth rate of confirmed cases remains the key chart to watch. Let’s see how it has been changing March and compare it with the dynamics of the S&P 500:

The growth rate decreased from 3% to 2% in early March, but then followed by rapid growth. On the S&P 500 chart, you can see that around that time the “rampant” sale began to pick up pace, which even the “almighty” Fed could not stop:

The argument is simple: the failure of the authorities to restrain the spread of infection entails expectations of more stringent quarantine measures, and consequently, the scale and duration of economic damage.

If history repeats itself, then after the Monday bloodbath, the time for a small correction and stabilization should come. Past recessions on average took 28% of S&P 500 market cap; on Monday, losses relative to the February 19 peak were 29.5%. It can be noted, however, that the past recession slashed more than 50% from the index, but then the situation was different – a high level of household debt, high use of leverage by key participants in the banking system, lack of reliable capital buffers from system-forming banks, toxic assets on the balance sheets. Now the financial system is much better prepared, and household debt is 25% lower:

However, in my opinion, one can count on a somewhat stable rally only if a serious package of fiscal measures is agreed upon and a steady decrease in the growth rate of the number of infected cases is achieved for at least a week. The chances of new uncontrolled outbreaks of the virus are declining as most countries are aware of the threat and won’t be caught off guard. Therefore, this risk factor in the perception of markets should be gradually fading into the background.

Disclaimer: The material provided is for information purposes only and should not be considered as investment advice. The views, information, or opinions expressed in the text belong solely to the author, and not to the author’s employer, organization, committee or other group or individual or company.

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