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Markets soared without signs of improvement

25 March 2020

The analogies with the times of the Great Depression are still with us. The American market spiked yesterday by 9.4% on the S&P 500 and by 11.4% on Dow Jones. Dow showed its largest one-day gain since 1933. It took a couple of weeks in 2020 to move from the biggest collapses, like in 1929 to comparisons for the start of the bull market in 1933.

Market optimism was powered by the extraordinary scale of support that Congress and the Fed promise the US economy. Yesterday lawmakers adopted a $2 trillion package, and earlier the central bank announced the start of broader and potentially boundless QE and other non-standard lending support measures.

The decisive and rapid steps taken by the government and the central bank, both in the US and in many other countries, clearly show that they did their homework by examining the adverse effects of delay. But a severe mistake in the 1930s was a false belief that the worst was over. The Fed then quickly tightened monetary policy to avoid devaluing the dollar.

However, there is a high probability that the US government – not the Fed – have overconfidence. The spread of the disease in the US continues to accelerate. Among all countries, the US is the most significant contributor to the number of new cases. Spreading speed demonstrates that the current restrictions are too weak.

Stricter quarantine measures may be needed soon, as was the case in many European countries, where restrictions were increasing until the rate of disease growth stabilized.

For markets, this means that it is likely that the American Dow Jones isn’t going through 1933, rather it is experiencing November 1929-April 1930 kind of jump. After that bounce, there was a reversal to a depressive, more than the two-year decline, which erased 85% of Dow value.

With hopes for stimulus alone but without fundamental grounds for economic growth, markets won’t be able to get on a firm footing.

So far, the reasons for optimism are external. In essence, a quarter of the US companies in China returned to work, while total quarantine in Europe is helping to contain the disease. Markets priced in the scale of the stimulus package in the US, but it is worth remembering that their view of whether this money is enough may change dramatically if the situation worsens further.

Investors should keep in mind that the situation is not yet contained, which means that markets will increase estimates of damage from the current epidemiologic crisis. After a few weeks of further jump in numbers, the current 2 trillion may not be enough to bring the indices back up.



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