Stock market plunge and Fed's caution
Abraham George Macro View
The stock markets stopped right in its tracks and made a U-turn yesterday. After almost 47% of rise from its lows since Mar 23, this was something we were warning that could happen for many days. We have been repeatedly writing giving statistical and anecdotal evidence that the relentless rise in the markets is not on solid grounds.
The rally was 100% sentiment driven, and the increasing faith investors started to maintain in the Fed, that they will come to their rescue in all situations.
Sentiment works both ways. Most participants convinced themselves that they are operating in an alternative reality where everything is rapidly returning to normal. The Fed’s comforting and soothing words on Wednesday added more “good feeling” to their spirits.
As we mentioned yesterday, if the recent run up has been driven by speculators on Robinhood, looking for an alternative to sports betting and doing insane things like buying up the stocks of bankrupt companies by triple digits what else should you expect?
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The S&P 500 dropped almost 6%. The worst single day fall since March rise. The Fed warned yesterday that the economy cannot fully recover until the labour market heals. The road to an economic reboot will take time and extraordinary policies will be required to get the economy back in shape. Add to that there has been soaring infection rates of COVID -19 in several states that have reopened for business. Meanwhile, Treasury Secretary Steve Mnuchin said shutting down the economy again is simply not an option.
The liquidity insurance that the Fed has pumped into the system should take time. If the economy comes back stronger and earlier, the excess money in the system should drive up the nominal GDP, a boom in asset prices and a rise in wages. This should also create a rise in inflation. The market was running ahead of itself. The Fed knows it is not going to really work the way the market thinks. If the economy were to come back too slowly, and the stimulus were exhausted, the Fed and congress are saying they would do more. But this will all happen at a great cost to the country.
So, the stocks cratered in no time. While the stocks tanked, bonds went up. Off late, there has been lot of rotation between these two asset classes. Gold did nothing much, while most would have expected gold to go up. The Euro very much held our significant resistance area and moved down.
We will have more detailed reports tomorrow after market close.
Abraham George is a seasoned investment manager with more than 40 years of experience in trading & investment and portfolio management spanning diverse environments like banks (HSBC, ADCB), sovereign wealth fund (ADIA), a royal family office and a hedge fund.