Juggernaut Rally

On February 19th, 2020, the S&P 500 hit an all-time high of 3,386.15. Thirty-three days later, on March 23, the S&P 500 closed at 2,232.40, a 34% collapse. Between February and April, 5.3 trillion dollars of the S&P 500’s market cap was wiped out from Covid-19 Pandemic.

S & P 500 YTD: Full Size

Fast forward to the end of May, where the index has recovered to 3,044.31. YTD the S&P 500 is now down just 5.77%. Not bad considering the economic numbers that have been delivered. The headliners – a 14.7 percent US unemployment rate in April of 2020, a 4.8 percent contraction in US GDP in Q1, and forecasts calling for another 30-40% contraction in Q2.


During the last weekend of May we saw mass riots break out across the country in protest of the killing of George Floyd and the institutional oppression that POC face in America. Striking images of police cars on fire, military carriers driving down city lanes, and standoffs erupting into violence plastered the front pages of every media outlets. Yet the equity markets keep rolling up, making this rally quite a juggernaut.

Two questions on top of the mind now.

  1. Given the terrible macro environment, what has brought the market back 36% in the last month and a half?
  2. Will this rally fade, reverse or head straight back into a bull market?

What has driven the rally?

The US equity rally has been driven by the Federal Reserve’s market intervention. While central banks across the globe have all committed to drastic interventions, the FED has spearheaded an aggressive domestic capital market backstop as well as two different foreign Dollar provisioning programs (CB Swaps and Repos).

Domestically, the FED’s expanded version of quantitative easing is a carrot and stick approach to addressing capital market liquidity. Hoarder’s face the devaluation of their cash while holders of real assets are enticed by the price increases created by the Fed’s capricious artificial demand. It is a gamble based on social theory rather than economic law, but so far it has seemed to be enough to get assets and cash moving again.


With enough dollars offshore to allow payments to continue being made, and with US companies able to obtain cash through security sales and financing, the market sentiment seems to be that most companies can ride out the storm. And once demand comes back, there should be no issue with the economy fast tracking back to previous levels. So far, this has proved to be a resilient theory. Additionally, as more and more money piles into the US in a typical flight of safety, investors on the sidelines feel more and more pressure to buy in.

S&P 500 vs the rest: Full Size

Will it last?

In 2014 Deustche Bank estimated that the S&P 500 companies represent about 15% of US jobs. As a percent of today’s labor market, this would be around 23 million jobs. Suppose we optimistically view these 23 million jobs as safe due to ensured access to capital market financing. In April, we also know that there were 32 million unemployed Americans. The initial claims rate has been dropping steadily, suggesting a possible peak to be near. The story of this recovery will thus be told by the remaining 100 million or so labor force participants.


Economies are driven by spending. This crash has been unique in that we saw spending turn off like someone had hit a light switch. This caused an immediate and enormous decline in economic activity. Will spending come at the flick of a switch back as well?

A key consideration is that the pandemic response was a manufactured demand shock. At face level, there is nothing wrong with the mechanisms for spending nor the supply of goods in the market. Unlike the Great Recession, where there was a systemic issue with the supply of capital that spread into issues in the supply of housing and credit, a lack of spending is a relatively straightforward matter – as long as the consumer base is not crippled.  

One sign of optimism is consumer savings. The US has always been a low savings rate economy. However, we can see that given the lack of spending opportunities, Americans have been storing a considerable amount of dry powder. The household savings rate was up to 33% in April. Per the FT, the FED has quite a bit of powder left as well, having only used about 4% of its 2.6 trillion-dollar commitment to the market to date.


It is not too difficult to imagine a light switch on scenario. If the FED can keep capital flowing as a backstop provider and direct lender, if technological advances have enabled WFH enough to keep the majority of small and middle market businesses floating, and if at the end, those currently unemployed are able to find work quickly in a post-quarantine spending boom. Perhaps some of those jobs will be provided through New Deal 2.0 type government programs, similar to the programs recently announced in South Korea. Of course, implicit in all this is a timely vaccine within current projections of being 6-months to 1-year out. With positive news being delivered from companies like Gilead (Remdesivir), Moderna (Moving to phase 2 Trials mRNA-1273), and Astrazeneca/Oxford (AZD1222) there is reason to be hopeful.

However, there are certainly several negative scenarios to consider. First, the quality of the rally. This rally is driven by the technology mega caps of America. With corona-proof business models and ample cash, they have become market favorites. A concentrated rally like this can be very vulnerable compared to a broad market recovery.

Tech vs the test: Full Size

A second and third wave of infections could turn this from a single lost year to two. Already there are troubling reports of a more persistent mutated strain in the Wave 2 coronavirus infections emerging from China’s second lockdown. Taking lessons from the Spanish Flu, we know that the second wave of a pandemic could be far deadlier and damaging then the first. A prolonged lockdown beyond current projections might turn the FED’s calculated gamble into a bluff.

There are also social and political questions to be addressed. Class disparities have been highlighted by the pandemic and tensions have risen to breaking point. In the US, Black and Latino communities are disproportionately affected by the disease. The riots in the last week of May 2020 were an inflection point to class-based and race-based frustrations that have been steadily brewing in the past 4 years. The stimulus that the FED has unleashed will to a certain extent be a double wealth transfer from the broad base of taxpayers to the wealthy who will benefit from both the stimulus and the fact that they hold the a disproportionate share of non-cash real assets. While this is an unavoidable side effect, added to today’s powder keg, it could prove explosive.

Geopolitically, the globalization movement has taken a serious setback. Outside the Federal Reserve, the US has led a nationalist agenda, attempting to hoard PPE, trying to negotiate first delivery on cures and refusing to participate in international sanction relief discussions. International condemnation has also been directed around China’s role in the pandemic, centering on the lack of transparency as well as the aggressive diplomatic moves China has made as part of its coronavirus PR program. This is all in the wake of the Hong Kong protests which have garnered strong international condemnation in its own right. The world’s reliance on China as a stop in nearly every manufacturing process will be revisited in a much harsher light. Given this situation between the world’s first and second largest economies, it is not hard to imagine a future where national retrenchment becomes the de facto policy. A decline in trade and integration however, would ultimately destroy value.

Summertime sadness?

The short-term price action of equity markets in the US will be determined by the volume of trading over the summer, the success of the reopening plans, and the Covid-19 testing capacity in the Fall/Winter of 2020 (prime wave 2 season). The medium-term variable will be whether or not the world can remain on track to a cure. All current stimulus packages, lockdown measures and government programs are based on the premise of a cure or vaccine being 6-12-months out. A setback on this would cause a significant repricing.  

In terms of trading volume, if there is a typical summer slump in market activity, we could see fade in equity price levels. Current price levels seem to be supported by high demand. Outside of the US, there are not many attractive opportunities to chase returns (though the margin is starting to close). There is also new demand generated from FOMO. With the market looking like it might start to peak, this bullish interest will drop. Looking at the Put/Call ratio on the SPY, it seems that market sentiment seems to anticipate a bearish correction as well.

Of course, this will be no ordinary summer. With nowhere to go, if bankers and traders stay in office and there is a generally orderly reopening, there could be enough volume to keep buying up the supply.

In terms of testing, the US is testing about 250,000 people daily at this point. Per Harvard’s Global Health Institute, the US may require closer to 900,000 daily tests to implement the effective level of contact testing that countries like South Korea have carried out. A fourfold increase in testing in a span of 4 or 5 months is a stretch. There has been good news in this front though, like the approval of self-collection testing kits by the FDA in the last week of May.

In the end, there seems to be too much vulnerability in the market for me to believe that things will kick back to 3,300 without any pause. I cannot be inclined to believe that the reopening will go without a hitch. With the unrest that has brewed creating the conditions for a tumultuous summer (remember Occupy Wall Street?), and a federal administration that has been unable to unify the country, the threat of social unrest alone would be enough to justify a correction in the near term.

Technically, the 2800-2900 zone showed a good bit of price action. I think there may be at least a correction to these levels. At 2850 the S&P 500 would be at around an 18% correction from its peak on Feb 19th. This strikes me as reasonable for a base case. This could be a slow-moving correction if the summer is quiet. However, the tail risk leans lower – a botched reopening, a summer of civil unrest, or new tariffs could easily push the projection to 2700.

Price Zone: Full Size

On the upside, unless we can confirm that a cure will come ahead of schedule, or reopening goes extraordinarily well, it would be hard to imagine much more headroom to go up. A market making new all-time highs in this current environment would be delusional, even with the heavy support of the FED. But by the fall, if the reopening was relatively successful and a change in White House Administration seems to be polling high, then we will have strong conditions to resume a growth outlook.

The final consideration here would be that there will likely be much longer-term implications from the events of the past 5 months, and those effects are not be priced in. Changes in the corporate real estate market, extinctions of certain industries, the consequences of another increase in federal debt, a revisit of global supply chains, a long overdue discourse on income equality, all these could be in the works. Even in terms of bankruptcies and earnings, the depth of the damage will not be known until later in the cycle. The market is forward looking but not omniscient.

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