In the last days of May there appeared to be a disconnect between economic reality and the stock market. The market moved higher amid alarming economic numbers. Over 38.6 million Americans are unemployed. According to the International Monetary Fund, the US GDP declined over -5% in the first quarter of 2020. Consumer spending declined over -13% in April. These statistics paint a dismal picture, but investors are buying stocks and pushing prices higher.
After being range bound from April 8 to May 22, on May 26th the S&P 500 index traded above its 200 day moving average for the first time since early March. The 200 day moving average is often a ceiling during bear markets when the index is trading below that price level. There is usually significant resistance or selling pressure at that level. When buyers create enough demand to drive the price above the 200 day moving average, it is a bullish sign and the former ceiling may become support as the market moves forward.
The 3 trillion dollars the government pumped into the economy several weeks ago has certainly supported the stock market, but it appears to be more than that. Investors are looking for any signs that the economy can re-open. Ultimately it will be businesses that bring recovery, not the government. In an emergency the government is needed to support the economy, but a robust business environment will sustain a market rally.
The market always looks ahead six to nine months so the rally is an indication that investors believe by early 2021 our economy will be on stronger footing. As states open in various stages investors are watching for positive change. Are consumers shopping, eating out, taking vacations? When a report was released that progress is being made on a vaccine, the market went up. Investors are obviously hopeful, and this optimism is fueling a rally in the market. While encouraging, hope won’t sustain the rally. Real economic improvement is necessary to support a rising stock market. Eventually the market will line up with the economy whether up or down.
Another observation over the past several trading days is the sector rotation. For most of the rally in April and May the strongest sectors were technology, healthcare, communications and select discretionary. These are sectors and individual stocks that stand to do well in an economy that is locked down with many working from home. The weakest sectors were financials, energy, basic materials, industrials travel and leisure, transports and utilities. Utility stocks are generally regarded as defensive stocks, however, in this downturn, utilities have declined on concerns over the impact unpaid utility bills may have on that sector. In recent days we have observed a rotation to stocks and sectors that were the most beaten down in the decline. That also seems to support the premise that investors are anticipating a recovery.
Even with the recent progress, we should expect continued volatility as the recovery unfolds. Triple digit up days can be just as dangerous as triple digit down days. It is all volatility. It is important to maintain a rational approach to investing and not be caught up in either the exuberance or the pessimism on any given day. A measured approach is important based on each investor’s own risk tolerance and time horizon.
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