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Dow Recovery Fades Because This Rally Has a Fake Fuming Bull

Last Updated September 23, 2020 1:47 PM
Ben Brown
Last Updated September 23, 2020 1:47 PM
  • The Dow Jones Industrial Average (DJIA) hesitated on Tuesday.
  • Investors initially cheered strong factory data out of China, but the rally soon faded.
  • There is little else to fuel the bullish rally as the coronavirus slowly cripples the U.S. economy.

The stock market fluctuated on Tuesday after Wall Street soured on Monday’s glorious relief rally. The Dow Jones Industrial Average (DJIA) bounced between gains and losses as it prepared to close its worst first quarter ever.

The Dow has jumped 20% from last week’s bottom, but analysts warn this is a classic dead cat bounce. ‘There’s no faith in this rally,’ said Credit Suisse strategist Mandy Xu. She thinks traders are simply using this opportunity to reposition themselves .

Investor sentiment remains extremely cautious. In the options market, investors have taken advantage of the bounce by resetting hedges, rather than adding to longs.

Despite promising factory data out of China , there is nothing bullish about the economic backdrop right now. A possible 32% of Americans face unemployment as the virus continues to ravage U.S. cities. The stock market’s biggest buy pressure has vanished, volatility is still near record highs, and oil hovers at 20-year lows.

Dow struggles for conviction

dow jones industrial average chart, stock market today
The Dow fluctuated during the quarter’s final trading session. | Source: Yahoo Finance

Dow futures contracts  initially jumped 1% on news that China’s factories returned to growth in March. But the rally faded quickly.

Major stock indices spent the morning session fluctuating between gains and losses.

  • The Dow rose 90.18 points or 0.4% to 22,417.66.
  • The S&P 500 gained 0.29% to trade at 2,634.15.
  • The Nasdaq jumped 1.05% to 7,855.81.

The stock market’s biggest buyer has vanished

The biggest buyers of shares are… the companies themselves. Companies bought more than $2 trillion of their own stock over the last three years, making them the biggest buyer on the market.

That buying demand has vanished . Goldman Sachs explains:

Buyback activity will slow dramatically, both for political and practical reasons. First, politicians are denouncing repurchases given the impending recession. Second, from a practical perspective, as revenues evaporate firms will be looking to preserve cash.

McDonald’s, Boeing, AT&T, Nordstrom, and JP Morgan Chase have all suspended their buyback programs. It’s hard to see this rally recapture its highs with the biggest buyer out of the market.

Unemployment is about to explode

Last week’s 3.3 million jobless claims was already a record. But things will get worse. A report from the St. Louis Federal Reserve estimates a total of 47 million unemployed  before this is over. That’s 32% of the population, pushing the country into Great Depression numbers.

These are very large numbers by historical standards, but this is a rather unique shock that is unlike any other experienced by the U.S. economy in the last 100 years – St. Louis Fed economist Miguel Faria-e-Castro.

Dow Jones can’t recover until volatility subsides

There’s another strong indicator that this rally is nothing but a head fake: the CBOE volatility index (VIX). The index just racked up ten-straight days above 60 – longer than any stretch during the 2008 crisis.

VIX chart
The VIX remains perilously high compared to the trading range during typical bull markets (marked red). Source: TradingView / CCN.com annotation

BTIG analyst Julian Emanuel said stocks may retest the low again before volatility calms. And only when it subsides will we see a sustained bull market emerge .

While the S&P 500 rallied 20%+ from its low during the week, VIX remained stubbornly elevated along with stock implied correlations… True bull markets tend to be low volatility and uncorrelated

Don’t read too much into the China numbers

Today’s stock market bounce is powered by surprisingly strong numbers from China’s factory output . It’s a positive development and shows light at the end of the tunnel. Eli Lee of Bank of Singapore explains:

The Chinese government is trying to project strength at this point in time to show that they are going back to business and their economy is on a strong footing.

China PMI tweet 

However, this bounce could be short-lived. Lee sees a longer recovery in China as demand from the U.S. and Europe drops off in the coming months.

I think over the longer term the market contour of this crisis for China markets is more likely to be a W or a U rather than a V shape. China is still very dependent on international demand for its goods. If the rest of the world falters in terms of economic growth, then it should prove to be quite difficult for the Chinese as well.