Looking for a ‘Santa Rally’ this year?
Looking for a ‘Santa Rally’ this year?
We’re in the last few weeks of an extraordinary year. We’ve seen the world blighted by a deadly virus which has led to devastating social and economic consequences. We’ve experienced a US election, following which, as in 2016, a vocal segment on the losing side refuses to accept the result. Meanwhile, the UK and European Union are attempting to slug out a trade deal before the 31st December when the UK finally leaves the single market and customs union.
US stock indices at record highs
Against this backdrop many investors find it surprising that all the major US stock indices are trading at or close to record highs. Casting our minds back, most global stock indices were hitting all-time highs in January and February this year. These highs were the culmination of a rally that began in December 2018, after a slump in global equities which followed a succession of interest rate hikes by the US Federal Reserve. The sell-off began in September 2018 and lasted three months during which the S&P 500 lost 20% of its value.
But equities bottomed out in December 2018 after Federal Reserve Chairman Jerome Powell performed an unexpected pivot. Coming under considerable pressure, not least from President Trump, he announced a halt to further rate hikes and then made a series of cuts which saw equity markets surge to record highs over the next fourteen months. That rally came to a screeching halt when the enormity of the coronavirus pandemic, and the associated lockdown, led to a calamitous decline in world stock markets.
This time, the month-long sell-off which began at the end of February this year saw the S&P 500 lose around 35% of its value. But a combination of fiscal and monetary stimulus from central banks and governments around the world contributed to the current rally that has taken US stock indices to the fresh all-time highs we saw last week. While European and most Asian Pacific equities have failed to take out their own record highs, they have certainly recouped a significant percentage of their losses from earlier this year. The gains made this year have seen the market capitalisation of global stocks top $100 trillion for the first time ever. To put that into perspective, global Gross Domestic Product was around $85 trillion at the end of 2019. Given the pandemic, that is quite a performance.
A lot of the commentary on social media and elsewhere focuses on this US stock market strength. It is driving some investors mad as they insist that the move in equities doesn’t reflect the fundamentals underlying the global economy. They argue that while the economic data coming out from the major economies is better than it was earlier this year, it is hardly earth-shattering. As an example, last week’s US Non-Farm Payrolls came in well short of expectations and the numbers continue to trend downwards since the summer. Despite payroll gains since May, there’s still a still a shortfall of around 9 million jobs from the 21.57 million lost at the height of the pandemic. Bearish investors argue that these job losses feed through to lower consumer spending, a reduced tax take and increasing social welfare costs. Thousands of small businesses have been ruined and many have disappeared for good. Moreover, the US (along with other countries) is experiencing rising cases of coronavirus with the US averaging as many deaths per day from Covid-19 as it was in April. Individual states, such as California, are going back into lockdown, once again threatening more business closures and a further economic slump.
A brighter outlook?
The bulls out there will argue that weak data like last Friday’s Payrolls raise the likelihood of additional stimulus. The feeling is that the major central banks are fully prepared to step in with bond purchases and other monetary measures. And why not? They’ve been doing it for over twelve years now, and all those worries about loose monetary policy leading to uncontrolled inflation have been wrong, so far. In fact, on Thursday market participants expect the European Central Bank (ECB) to announce a boost to its existing stimulus measures. Not only does the Euro zone need more help, but there is the problem of the strength of the euro which is currently at its highest level against the US dollar since April 2018. That is a problem for Germany as it is a major exporter that needs a cheap currency to help it remain competitive. But while central banks may be prepared to step in as long as the coronavirus pandemic is with us, they have been pleading for years for governments to step in with additional fiscal measures. After all, the balance sheet of the major central banks is well over $20 trillion. The Federal Reserve balance sheet exceeds 34% of US GDP, while the ECB’s is over 61% of Euro zone GDP. The latter shows just how difficult it is to get governments within the Euro zone to agree on fiscal matters. But we should bear in mind that US politicians have been arguing since the summer over a replacement for the coronavirus stimulus programme which ended in July. Even with the election out of the way, the wrangling continues over the size and scope of a new package.
But there are grounds for optimism and stock markets are forward-looking. Vaccines have been developed in an incredibly short space of time, and are starting to be administered, at least in the UK. Not only that, but it should be apparent to traders that the stock market is not the economy. But where there is a significant overlap is where governments and central banks intervene by providing fiscal and monetary stimulus. With interest rates at near zero or even negative, the stock market is where investors look for a return on their money, no matter how many indicators and measures warn that company shares are ‘overbought’. Can this go on indefinitely? Probably not. At least not without some sizable corrections along the way. Trying to predict when corrections will happen is where technical analysis can help, although it’s far from being perfect.
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