Daily Outlook

A new avalanche in the markets. Who will buy now?

Stock indices are recovering some of their losses after a powerful sale the day before, comparable to what we saw in mid-March. On Thursday Dow Jones lost 6.9%, S&P 500 collapsed by 5.9%, Nasdaq dropped by 4.6%. The trigger was probably fears of a new surge of infected in the U.S.A. The anti-racism demonstrations in the country in the previous two weeks are likely to worsen the pandemic situation further.

In the coming days, it is worth keeping a close eye on the markets, where a more profound correction may begin as well as a return in demand from buyers. Futures on S&P 500 fell to the 200 SMA yesterday, where they got support, adding 1.2% on Friday morning. A similar recovery in demand for risk assets is also observed in FX, where yen and franc are declining against the dollar.

Fed's balance sheet expanded by just $4B last week, contributing to markets pessimism
Fed’s balance sheet expanded by just $4B last week, contributing to markets pessimism

The recovery of the stocks, observed for almost three months, has gone too far, making indices vulnerable to bad news. Yesterday’s decline resembled an avalanche, which starts as alarm bells start ringing. There have been several such alarm bells.

Influential forecasts of the Fed showed that in the next two years, the economy wouldn’t offset its losses. And the head of the U.S. Department of the Treasury Steven Mnuchin noted that the country could not afford another lockdown. This is a vivid reminder that the second wave of the Spanish flu in the 1920s was the most devastating, precisely for the same reasons as the government could not afford to pay again to stop the economy.

During the previous months, small players supported the market. Retail investors were imbued with the idea of restoring the stock market, believing that it would endlessly grow thanks to the Fed.

SPX drop by the most since March, but find support now at 200-SMA
SPX drop by the most since March, but find support now at 200-SMA

The same mistakes were characteristic of the housing boom in the early 2000s, and that didn’t prevent prices from losing about 30% in the following years. We must not forget that markets can fall for years. The decline in stock indices continued for over three years after the peak in 2000 and more than two years after 2007th peak.

Now the Fed assures that it won’t make mistakes of the 1930s and will not rush into tightening. But this does not rule out another fact. Income for so many people has fallen sharply in recent months, which promises to reduce the flow of fresh money to markets. At the same time, the Fed is reducing its purchases on the balance sheet, while business is reducing its investment plans, and governments are being more careful about spending.

The only purchasers with bottomless pockets now are central banks. Once again, the central bank looks like a buyer of last resort. However, the stocks recovery and normalization of liquidity in financial markets allowed them to weaken the grip, which immediately affected the markets. In the short term, a lot depends on faith in the Federal Reserve’s actions. But this is a very fragile faith.

The FxPro Analyst Team

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