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Baseless Dow Rally Hype Risks Another Epic Stock Market Crash

Last Updated September 23, 2020 1:48 PM
Laura Hoy
Last Updated September 23, 2020 1:48 PM
  • Coronavirus cases are likely to continue rising dramatically in the U.S.
  • Corporate earnings will put a damper on the Dow’s rally.
  • False hope is creating a flimsy rally that many will use as a profit-taking opportunity.

U.S. stock futures pointed to a higher open on Monday as welcome news regarding the coronavirus pandemic buoyed hope among investors.

Both the Dow Jones Industrial Average and the S&P 500 looked poised for a 4% rise at the start of trading. But the positive sentiment may not be based in reality, creating another baseless rally doomed to end with a stock market crash.

Coronavirus Creates False Hope for The Dow

US coronavirus cases
The drop in new cases is something to celebrate, but it doesn’t necessarily indicate a lasting trend| Source: Worldmeter 

Investors celebrated a drop in new cases, sending Dow futures on the Dow 800 points higher, but at the same press conference, Donald Trump also warned of “horrific” days ahead as total fatalities rise. 

We will reach a horrific point in terms of deaths from coronavirus, but from that point, things will start to change. We are very close to that level.

The decline in cases is undoubtedly a positive, but the Dow’s celebration is premature. New York, the hardest-hit state in the nation could be nearing its apex of cases, though Governor Cuomo says it’s too soon to tell.

Governor Andrew Cuomo revealed New York is likely to hit its coronavirus peak in a week but warned “we’re not yet ready for the high point.”   | Source: Spencer Platt/Getty Images/AFP

One day of improving statistics is a dangerous way to kick-off a stock market rally. According to Matthew Harrison at Morgan Stanley, social distancing measures will likely extend into May . He believes the U.S. will reach a peak of 570,000 cases at the end of April. 

Importantly, this new forecast continues to assume more social distancing and a continued rapid increase in testing. We would highlight that the biggest risk to this forecast is that while we have reasonable confidence the East and West coasts will reach peak cases in the next 2-3 weeks, the interior of the country is now exhibiting signs of new outbreaks.

Harrison pointed out that the U.S. has more relaxed social distancing measures than most countries, which could play a role in exacerbating the spread. With that in mind, it would be reasonable to expect the that the U.S. will take more time to reach a peak than Italy. 

Coronavirus, stock market crash, the dow
The U.S. more relaxed social distancing measures suggests it will take more time to reach the peak of cases |Source: MarketWatch 

[The data are] pointing to a significantly faster elevation of case numbers in the U.S. than Italy.

Earnings Will Bring the Stock Market Down to Earth

the dow, s&P 500, stock market
The Dow’s rally can’t be trusted with dismal earnings ahead. |Source: Yahoo Finance 

Chief Global Equity Strategist at Goldman Sachs, the stock market hasn’t realized the scope of this downturn. For that reason, there’s more pain ahead .

Despite the scale of the policy support, which we agree is a necessary condition for markets to rebound, we think it is too early and the level and valuation of equity markets still too high

With earnings season upon us, investors will soon confront the stark realities that U.S. companies are facing. Many are up to their eyeballs in debt and demand has all-but dried up. Their ability to weather the storm is fading fast, but the timing of a return to normalcy is still an unknown. 

That’s evident in the wide range of price targets among analysts this earnings season. UBS strategist Francois Trahan said as much in a note warning that the unprecedented coronavirus fallout means everyone is flying blind .

Such a large range of opinions on the part of analysts covering the exact same stocks highlights the absolute lack of visibility. This could also be considered as a proxy of the confidence that analysts have in their earnings/price targets