So why is the stock market rallying if 20% of the country is unemployed?

Our thing is day trading—holding as necessary out to a couple of days. We trade currency pairings both long and short. We read the markets price action—the value, setup and signal. We do this technically, which means we read a chart and without the undue concern about fundamentals.

However, you also have money in medium-term funds. Al Brooks is an exceptional short term trader and teacher. Those abilities have technical relevance in all timeframes. Here is what Al says about the medium term. It relates to the S&P 500, but as we have noted before, all markets in some way or other will follow the S&P—often much slower if it’s good news, but much quicker if it’s terrible.

With interest rates at or approaching zero, you may be thinking that the medium-term share/stock market is the only option. Maybe, but I’m content taking the short term technical view. Below explains why.

How far will the stock market fall?

The pandemic will lead to unemployment comparable to the Great Depression that started in 1929. The stock market fell almost 90% from its peak in the 1930s. Why is the market rallying so strongly when the unemployment and GDP now are the worst since the Great Depression?

One reason is that we now have a Fed; brilliant, bold people who have learned from the past. The Fed Governors have said that they will effectively create infinite dollars to prevent the destruction of the economy. Investors see that as the Fed placing a floor under the market. 

I think investors and traders are getting this wrong. The market is down only 10 – 20%. The Fed’s floor would be around 50-60% down from the high. There have been many selloffs in that range since the Depression, and we completely recovered each time. I, therefore, think that the Fed’s real floor will be about 50 – 60% down from the high. The market is up in part, simply because investors believe there is a floor somewhere. 

We live in a country (US) with a relatively free market. The Fed wants it to stay that way. They, therefore, will not intervene as quickly as many investors hope.

Investors and traders who are buying at the current price think they are buying just above the Fed’s floor. They are not. The base is far below, and these traders will discover that the support that they expected is not where they assumed it would be.

The rally is technical.

So why is the market rallying so strongly? The pandemic (we assume) is not going to be as bad as the bubonic plague in Europe in the 1300s. Also, institutions love what the Fed is doing. 

These are both necessary for the rally, but the sine qua non is the technical or chart pattern.

The market is merely repeating a behaviour that it has done thousands of times on all time-frames. It is no more complicated than that. Experienced chart readers know that, and they are trading with that expectation. 

The stock market probably would not be able to do it as strongly as it has without the (good) news about the pandemic and the Fed. However, that technical pattern merely is unfolding as it usually does. 

Traders and investors should soon expect a test back down, and then a trading range. That range will be a continuation of the last 30-month trading range, and it will probably last all year.

The stock market and the pandemic

Al Brooks is a trader and previously a physician with some virology expertise. These are his (re-written) thoughts on the pandemic and its effect on the stock market.

Impact of the pandemic

When the pandemic struck in February, traders were confident of one thing. They knew it would drastically change the behaviour of consumers. 

Since consumer spending is responsible for 70% of the GDP, companies would make less money or even lose money. Earnings determine the value of companies. If the total revenues of America’s companies were going to be less, the price of stocks had to fall. 

No one knew how bad the unemployment and the reduced spending would be. But everyone knew the economy would be wrong. It took a while for America to conclude that life will not get back to normal until there is a vaccine next year.

The stock market leads the economy

The stock market is a futures market. People buy a stock based on what they think the price will be in the future. Therefore, the market typically goes down before there is a recession and up before a recession ends. 

The market has rallied sharply over the past four weeks. Traders concluded that a 34% reduction in the stock market’s price was more than what was needed. 

The market is now in search of a price that is appropriate. Traders concluded that the February high is too high and the March low is too low. Somewhere in the middle is just about right. 

It will take many months to find the theoretically fair price. As traders become more confident of what the reasonable price is, the legs up and down will get smaller. 

After many months of equilibrium, traders will become confident that there is no more significant risk of a 2nd or 3rd wave of infections and economic damage. Traders will begin to ignore the pandemic and then life will start to get back to normal, or at least a new normal. Once that happens, the bulls would try to create a rally to a new high.

The vaccine will probably work

Traders want to know that a vaccine will work. Vaccines work for most viruses, but not all. HIV is an obvious example. It took decades to create a reasonably good treatment for people infected with HIV. A satisfactory treatment is one that helps the patient and dramatically reduces the chance of spreading the virus to others. 

For COVID-19, it would probably also take many years to develop a comparably effective treatment. Treatment without a vaccine would have the world living with the virus indefinitely and possibly forever. That dismal prospect would be a chronic weight on the economy. 

Remdesivir might help

There was a report this week from the University of Chicago, concerning Gilead’s Remdesivir. They used it to treat 113 patients with severe disease—most discharged within a week. 

While it is good that the drug appears to reduce the death rate, it is not enough to make American life healthy again. Being on one’s death bed and then surviving is better than not surviving. But whoever wants to be so sick that he is on a deathbed? That is not our regular life.

It is important to note that there are politics in everything, including medical research. Also, there are statistical abnormalities that result in what appears to be a good result but is just a coincidence. Doctors know this and therefore want to see similar results from several medical centres before being confident that a drug is beneficial.

What traders want from a vaccine

Traders want a vaccine that will prevent infection in a large percentage of the population. For example, the flu vaccine only works in about 70% of people who get vaccinated. People want a more reliable vaccine than that because COVID-19 is a more severe illness. Traders also want the protection to be permanent or last at least several years. 

Viruses mutate. If they mutate enough, the old vaccine is ineffective.

Finally, traders want to be sure that a vaccine will not have horrible side effects. If it does, many will refuse to get vaccinated. The result will be lots of people choosing to risk getting sick and passing the infection to others. That would prolong the damage to the economy. 

These uncertainties will be here for another year. That will probably keep the market sideways into 2021.

But what if the pandemic is not the main problem?

The stock market was the most overbought in its 100-year history. It will probably take a decade for the fundamentals to catch up to the high price. 

That is what happened after the buy climaxes in the 1960s and the 1990s. Each led to about a decade of sideways trading. There were 50% selloffs and 100% rallies, but the market was in a trading range. The market sometimes made new highs, but they led to a reversal back down instead of a bull trend.

The stock market has been in a trading range for over two years and will probably continue so for the rest of the decade. However, there will be at least one more new high. It might even come next year. But the market will likely have a difficult time getting far above this year’s top for a long time.