By Hussein Sayed, Chief Market Strategist at FXTM
World and US stocks continue to trend higher as investors become more optimistic about the pace of the economic recovery from the Covid-19 pandemic and gave little attention to the ongoing US-China confrontation over Hong Kong.
Technicals vs. Fundamentals
Looking at the S&P 500 index chart, bulls seem to be in strong control. The index is not only up 38% from its March 23 lows, but has also cleared significant psychological hurdles.
1 – The index closed above 3,000 for the first time since March 5.
2 – It has crossed above the 100 and 200-day moving averages, a signal for further upside.
3 – It is comfortably sitting above the 61.8% Fibonacci retracement (from the February all-time high to the March low).
For many traders, basing their analysis only on technicals, these are all considered signs for a prolonged bull market.
More interestingly, Wednesday’s 1.5% rally was not driven by momentum and growth stocks, but value ones. Financials, Industrials, Telecoms and Consumer Non-Cyclicals were the drivers of the rally, while the Tech sector was the laggard. This could also revive hopes that value investing may return, after being out of favour for almost a decade.
It has become clear that investors are not positioning their trades based on the expected next two or three quarters earning’s results, they are looking well beyond that.
However, even when analysing two-year forward P/E multiples, the index is still sitting at a valuation near 23x, which is by any means significantly expensive. Of course, earnings estimates will be revised several times over the next quarters and will vary substantially based on upcoming developments. What seems to be priced in at this stage is the economy will recover much faster than previously estimated, the pandemic will soon end and life return to normal.
Hopefully, markets are correct in their assessment, but when looking at current facts, the chances of disappointment are high – bankruptcy cases and store closings are piling up on a worldwide scale and at an unprecedented speed, the unemployment rate will take several years to return to pre-Covid pandemic levels and consumers will lower their spending levels for several months before becoming confident enough to open their wallets.
Add to this the risk of a second coronavirus wave and a US-China cold war and we find that equity markets are becoming extremely overstretched.
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