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Analytics, 17 August 2020

Volatility swing for the US stock market

The major U.S. stock indexes posted strong weekly gains last week and early this week which suggests investors are betting that the fundamentals would remain reasonably supportive despite potential headwinds over the inability to contain the spread of coronavirus and possibly another three-weeks of stalemate over the next fiscal stimulus package.

All indices show that the markets have been nearly up from the March lows when the Covid-19 lockdowns first struck the market. Though the pace of the economic recovery is slowing, data continues to show steady progress. The price action suggests investors are betting on the recovery while showing little concern over the pace.

In the cash market last week, the benchmark S&P 500 Index settled at 3372.85, up 101.73, or +3.11%. The blue-chip Dow Jones Industrial Average finished at 27931.02, up 1502.70 or +5.69% and the tech-based NASDAQ Composite closed at 11019.30, up 274.02 or +2.55%.

Are rising yields a good sign for the economy?

Helped by decent economic releases, last week saw a rise in US yields. Helped by better-than-expected data and an uptick in consumer inflation, government bond yields hit a two-month high.

Just two weeks ago, there were simmering talks of negative rates as yields hit historical lows and last week’s rally came as a relief for investors. The increase in yields was supported with data that initial jobless claims fell below one million for the first time since March, and U.S. retail sales continued to rebound in July, even exceeding pre-pandemic levels.

However, did yields rise because of an improving outlook for the economy, or because of a massive Treasury refunding? How the coming weeks unfold will provide clarity as investors will continue to watch the COVID-19 numbers, especially the impact of a potential three-week delay in getting financial aid to consumers.

The impact of the stimulus delays would be interesting to look into, especially since the market didn’t seem to substantially react to the news that Congressional leaders were going on recces until after the September 7th Labor Day holiday. This means that the lack of fiscal relief is a short term risk but also that the investors feel the worst of the pandemic’s damage to the economy is over and that the fundamentals are likely to remain reasonably supportive.

A lower volume season could be on the way.

If investors perceive there is a short term risk, they are likely to shield their portfolios and wealth by buying protective inputs as we are seeing with the surge in the gold market.

The stock market is very reactive to news, and any surprise news will likely trigger an even steeper break. With the summer winding down and another earnings season months away, the volume of stocks could considerably dip as some of the major players take a vacation from trading.

Low volumes are known for fueling volatile swings and if we add the unpredictability that we’ve seen this year, analysts think there is a possibility of this happening in the next three weeks or so.

Investors seem aware of these risks, as they have remained active despite all the damage the pandemic has caused in the economy – the worst plunge in unemployment and output in history and escalating U.S.-China trade relations. But they also know that the stimulus is likely to come hence their on-reaction to the delay.

After Congress come back from recess in September, volume and volatility should pick up again over the next three weeks. But after that, the market will have to deal with the economic data from August and the Presidential election.

Since there was no stimulus package in August (the last one ended in July), economic data will reflect this – and the data could be considerably lower than for July. In terms of the presidential election, investors will monitor who between Biden and Trump is leading and likely to win the election. This is the volatility that could be on the way.

Another indicator of the impending volatility is the recent dumping of growth stocks and the moves into value stocks which show that major investors are hedging their risks ahead of the impending uncertainty.

How should investors prepare for the volatile market?

The next three weeks are likely to present the “calm before the storm”. Investors need not be complacent during this period as most could be caught off-guard, triggering the return of volatility.

Manage your risk. Risk management is one of the most important steps for any trader or investor. A lot of events that directly affect the markets and the global economy can happen out of the blue. You need to be ready to raise your bets or cash in some chips. Continually review your existing holdings and update your watchlists.

Other things to consider include: making sure you have the right asset allocation; reviewing your investment strategy; committing to thinking long term; consider investing more if the market crashes; and not spending your time worrying about the state of the market as the market will always rise and fall, crash, recover then crash again.

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