We’re always reminded that it’s darkest before the dawn, but never that it’s always brightest before the dusk. That’s something investors might want to remember following a stellar week for stocks.
By all appearances, all is well with the market. The Dow Jones Industrial Average gained 779.74 points, or 3.3%, to end the week at 24,465.16, while the S&P 500 index rose 3.2%, to 2955.45, and the Nasdaq Composite climbed 3.4%, to 9324.59. It was the Dow’s biggest gain since the week ended April 9.
The week offered plenty of reasons for optimism. It started with Federal Reserve Chairman Jerome Powell striking an optimistic tone when interviewed on 60 Minutes this past Sunday. Then Moderna (ticker: MRNA) revealed the results from eight patients in a Covid-19 vaccine trial, results that showed that the vaccine might be working. (We say might because the trial itself was only Phase 1, and eight people isn’t nearly enough to reach a rational conclusion.)
Finally, more states are reopening just in time for Memorial Day weekend, suggesting that life is very slowly getting back to something resembling normal. It was enough for the S&P 500 to close just off its highest level since March 6.
Sometimes large weekly gains can be deceiving—and despite the rise, the S&P 500 hasn’t really gone very far since its April peak of 2939.51. From April 29 through May 22, the index has gained just 0.5%, less than its daily average move of 1.2% in either direction since then. The market, if anything, has been going nowhere.
And there’s a good reason for that, explains Citigroup strategist Robert Buckland: The S&P 500 is stuck between two competing forces. On the one hand, there’s the $6 trillion of central-bank asset purchases globally that have created a bid for the market. On the other hand, there is the offer, keyed to what could be a 50% drop in global earnings in 2020. “For now the bid is winning,” Buckland writes. “[But] we suspect the offer isn’t done yet.”
The battle between those two forces is apparent when looking at where the S&P 500 stands in relation to its 50- and 200-day moving averages. The 50-day, a short-term measure of the market’s trend, sits at about 2730 and should offer the market some support. The 200-day, however, sits at 3000—just 1.5% above Friday’s close—and offers obvious resistance.
For now, one is the immovable object and the other is the unstoppable force, and the S&P 500 has been stuck trading between them for 21 consecutive days.
If history is a guide, the next move is almost certainly lower. This was just the 30th time since 1928 that the S&P 500 has remained between the two moving averages for at least 20 days, according to Sundial Capital Research’s Jason Goepfert. Of the 29 previous times, the S&P 500 broke lower through the 50-day 21 times and traded higher through the 200-day just eight times, suggesting there’s a 72% chance that the next move is down.
It’s worse than that, though. Goepfert notes that even when the S&P 500 has broken through its 200-day moving average, the index has consistently traded lower over the next six months, with an average decline of 12.7%.
“The trouble is basically that buyers haven’t shown enough oomph to make any progress lately,” he writes. “When that happens during downtrending markets like we’ve been in, with a protracted stretch near but below the 200-day average, it has indicated larger problems and that has almost always meant further weakness ahead.”
It isn’t the only aspect of the market suggesting that trouble is ahead. David Rosenberg, chief strategist at Rosenberg Research, broke the market down into indexes representing the themes driving stocks now—and they show there isn’t as much of a disconnect between the economy and the markets as many may think.
While the S&P 500 has dropped 8.5% in 2020 and the Nasdaq Composite has gained 7.8%, the companies in the firm’s Payment Stress index—those that depend on regular streams of cash flows, like banks and real-estate investment trusts—have fallen about 25%, while those in its Reopening index—which includes companies that benefit from renewed economic activity, like Simon Property Group (SPG), United Airlines Holdings (UAL), and Hilton Worldwide Holdings (HLT)—are still off about 40%. For Rosenberg, that’s a warning sign. “[Do] not chase the rally,” he says. “There is a significant chance we retest the lows.”
What makes today different than the market’s all-time peak on Feb. 19 is that the risks are now known—only the outcomes are unclear. There will almost certainly be a second wave of Covid-19 in the fall. The recession will be the deepest since the Great Depression. And tensions between the U.S. and China, which ended the week by proposing new security measures for Hong Kong, are almost certainly going to be a permanent part of the landscape. The results could be far better than expected, but they could also be far worse.
If nothing else, after the S&P 500’s rally off its March 23 low, it’s a lousy time to buy. Even if you’re not ready to embrace the bear.
Write to Ben Levisohn at Ben.Levisohn@barrons.com