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It depends on whom you ask.
An eternal question in financial markets is: what is priced in?
The question is sort of silly on one level and the only question worth asking on another. The market’s current rally off the March 23 lows has fanned the flames of a tense debate over whether stock prices are too high, what assumptions those buying equities right now are making, and why stocks are likely to go up or down from here.
The global strategy team at JPMorgan summed up consensus thinking on what’s driving this rally nicely on Tuesday, writing in a note to clients:
We believe that a bullish environment in equities and risky markets is underpinned by six factors: liquidity injections; zero cash rates and low bond yields; the presence of an equity short base and equity underweights among investors; the defensive nature of the risky market rally so far; the relaxation of lockdowns and signs of bottoming out in economic expectations; and last but not least the rapid healing of credit markets.
There are, of course, many things investors know with some degree of confidence.
What investors do not know is what an economic rebound from this global forced stop of activity looks like. And investors do not know what actions the Federal Reserve and other central banks might take in the future.
And while strategists on Wall Street are often criticized for herding and offering similar opinions to a diverse set of questions, the current moment has seen a wild divergence between views on just what is being priced in to the market at current levels.
Benjamin Bowler and the global equity derivatives team at Bank of America Global Research argued in a note published Tuesday, for example, that the S&P 500’s rally can only be seen as investors betting on extreme outcomes.
"Given the strong relationship between the length of bear markets and that of recessions, equities are either betting on a record short recession (despite forecasts for near the worst in history), or on the Fed buying equities, believing fundamentals don't matter,” the firm writes.
“However, while the Fed has surprised in terms of the lengths it will go, it is far from buying equites and likely would only consider it if pressed by new lows. There may be a time to co-invest in equities with the Fed, but it will surely be at lower prices."
In this Tuesday, Oct. 26, 2018, photo specialist John Parisi works at his post on the floor of the New York Stock Exchange. (AP Photo/Richard Drew)
As we’ve highlighted before, Bank of America’s own economics research group is expecting the worst recession on record as a result of the forced stoppage in economic activity during the second quarter.
And while calls have grown that the worst of the economic decline is behind us — Goldman Sachs’ Jan Hatzius said in a note Monday that “economic activity has probably bottomed now” — few expect this downturn to be short-lived.
Nicholas Colas, co-founder of DataTrek Research, said Tuesday, however, that the market is in his view “evenly balanced” right now.
“At [Monday’s] close we’re 19% away from the February highs and 21% off the March lows – pretty evenly balanced, in other words,” Colas writes. “As bits of news come out regarding the restart, we’ll see the market shift its perspectives on the 2021-and-after economy. We expect this will come in ‘2 steps forward – 1 step back’ fashion."
But Colas believes that while policy actions have been a part of this market rebound, there is something deeper being reflected in the market’s relative optimism about what the future holds.
“COVID-19 has been an existential crisis – one more than capable of overwhelming traditional policy tools,” Colas writes. “Investors have thus far voted to believe global economies and social structures are equal to the challenge.”
