The stock market’s 5% decline at the end of last week could signal trouble ahead if new virus cases continue to spike in the U.S.
After making its way above 3,100 on Tuesday, the S&P 500 saw a sharp drop-off. The index ended the week 5% lower as investors fretted about the global pandemic. Since its March drop, the stock market has been defying gravity with only the occasional stumble. Is this time different or was last week’s decline the start of something larger?
Technical indicators suggest there could be more pain ahead. Since mid-June, the S&P 500 has tried to break above 3,150 three separate times. Every time it’s failed, it’s been a sign of weakness for the stock market.
Some market timers are looking at the S&P 500’s 5-day and 13-day moving average anxiously. If the 5-day moving average remains below the 13-day moving average for a significant period of time, it suggests another drop is in store.
After the stock market fell lower on Friday, the S&P 500’s 5-day average sunk well below the 13-day moving average. If that trend continues on Monday and Tuesday, market timers take it as a sign of a further decline.
There’s good reason for investors to be getting skittish according to the International Monetary Fund. In its six-month global financial stability report, the IMF cautioned that the stock market’s air of optimism is disconnected from the economic reality around the globe. The fund noted that investors’ dependence on more monetary support from central banks could end badly.
Markets appear to be expecting a quick ‘V-shaped’ rebound in activity […] This has created a divergence between the pricing of risk in financial markets and economic prospects.
Debt, the IMF warned, is becoming a real concern that could ultimately put banks at risk.
This deterioration in economic fundamentals has already led to the highest pace of corporate bond defaults since the global financial crisis, and there is a risk of a broader impact on the solvency of companies and households
The IMF also cautioned that a second wave of infections could cause another sharp pullback in the stock market. A prediction that already appears to be coming true in the U.S.
Virus news continues to be a major driver for the stock market, and this week evidence of spiking case numbers in several U.S. states spooked investors. A big part of the reason for the equities strong recovery in recent weeks was the rapid reopening of the U.S. economy. Consumers were proving resilient as businesses opened their doors, seemingly confirming predictions for a V-shaped recovery.
Even the brightest forecasters admit that a resurgence in infections would be a worst-case scenario. That’s why the skyrocketing coronavirus cases in Texas, Arizona and Florida have many traders biting their nails.
In Texas, lockdown measures have been re-implemented to try and control the rising number of new cases and Florida bars have been prohibited from serving alcohol. Similarly, states like North Carolina have put reopening plans on pause to avoid further outbreaks.
Meanwhile, Federal funding for some coronavirus testing sites, including several in Texas, is set to end this month.
The Trump administration’s decision to stop funding the community testing sites has sparked a hot debate. Some claim it will make virus testing in hot-spot areas harder to come by. Trump and his team say the decision won’t withdraw funds for testing. Instead, they claim it will reallocate the federal funding in a more efficient way.
Whatever the case, if the US doesn’t get a handle on these outbreaks it could set the stage for a significant stock market correction in the week ahead.