This week I have been making the case for fading this market re-opening rally. I did not expect it to fall apart straight away. But yesterday we saw the first chinks in the armor. So let me tell you what I’m thinking now. This will be brief.
Yesterday was not necessarily the re-assertion of a major risk-off move. There was no new macro information driving events in my view. The concept that there was some sort of catalyst causing a 5%+ meltdown is laughable. We were simply coming from deeply overbought levels. And although the market remains overbought in my view, yesterday was a shot across the bow for the retail investor set. It showed them that stocks don’t just go up; they also go down.
But, more than that, it showed us that when a major move occurs, downside resistance could be less than we think. That means the next downside move that is precipitated by a fundamental change in economic or viral data will probably be associated with a major air pocket in the equity markets and a wholesale shift into safe assets. We’re not there yet.
This feels like a phase shift though. It feels to me like we have entered a new period where nagging worries about a V-shaped recovery cannot be ignored. That’s a phase during which bad data will matter and result in market sell offs. While good data might work to keep things elevated. But the Nirvana narrative of re-opening and V-shaped recovery has received its first major blow. More are sure to follow. And they will be met with selling.
My ultimate worry is not that the bear market eventually reasserts itself. Rather it’s that the bear market reasserts itself because of a fundamentally brutally negative macroeconomic outlook. The dispersion of potential economic scenarios includes ones in which we have major credit events and lingering unemployment at post World War 2 record levels for months to come. And it also includes outcomes where viral contagion remains a lethal threat for a couple of years, where herd immunity is the only viable solution.
The narrative driving markets is nowhere near as dour – hence the rally in shares. But, if that’s the reality that awaits un in 2020 and 2021 and potentially 2022, then there is a lot more downside in equity markets to come. I am betting that we will have a very good handle on this by September and October.