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U.S. Stocks Revival Fakes Out with 1929-Esque Bull Trap Warning

Last Updated September 23, 2020 1:46 PM
Joseph Young
Last Updated September 23, 2020 1:46 PM
  • The U.S. stock market is set to open with a 2% drop after a strong day of recovery on Thursday.
  • Analysts believe the recent upsurge resembles the 1929 Great Depression bull trap.
  • The number of coronavirus cases is still rapidly increasing and there are no clear fundamental factors to support an extended stocks rally.

The U.S. stock market is set to open with a 2% drop  as it pulls back from Thursday’s 1,350-point Dow Jones rally. But, analysts are unconvinced of the stocks recovery, pointing towards the massive bull trap in 1929.

During the Great Depression, the S&P 500 plummeted by more than 34% . In the 48 hours that followed, the U.S. stock market saw an upsurge of more than 18%. Then, in the subsequent 13 days, the S&P 500 fell by another 26%.

Based on the historical data, Crescat Capital portfolio manager Otavio Costa said the recent stock market trend has an eerie resemblance of the Great Depression fakeout.

stock market
A bull trap in the U.S. stock market during the Great Depression in 1929 | Source: Otavio Costa /Twittter

Makings of a big stock market bull trap

Earlier this week, major financial institutions including Bank of America (BofA) predicted an “economic collapse”  in the second quarter of 2020 purely based on the record high unemployment rate in the U.S.

The bank warned that a recession has already hit the U.S., and the number of jobless claims that exceed 3 million  shows the magnitude of the economic shock.

Yet, the U.S. stock market rallied by more than 6% on a single day, with 3.4 million individuals out of the workforce and the number of coronavirus cases rapidly increasing.

Workers in protective gear operate a drive-through COVID-19 mobile testing center on March 13, 2020 in New Rochelle, New York. On March 26, 2020, the United States overtook China for the highest number of confirmed coronavirus cases.  | Source: Spencer Platt/Getty Images/AFP

The coronavirus pandemic, which triggered the steep correction of the Dow Jones, is worsening on a daily basis, and the U.S. overtook China to become the most infected country from the virus on paper.

Strategists have consistently warned that unless the coronavirus outbreak in the U.S. gets contained, there is little basis for the stock market and the economy to rebound from.

If fiscal policy is the sole reason behind the short-term rebound  of the stock market in the past several days, investors predict a high probability of it being a dead cat bounce.

Why did the stock market really recover?

At a technical level, two main factors could have led to an abrupt rally of U.S. stocks: traders with stock market put options taking profits  and short contract holders being squeezed out of their positions.

As seen with Tesla, when asset or an index gets overly shorted , technical indicators begin to demonstrate oversold conditions. It often results in a short squeeze, leading short contract holders to adjust their positions. The squeeze then turns into buying demand, pushing the market upwards.

Apart from the government’s vamped up spending, there is no clear fundamental factors that could trigger a strong stock market upward momentum in the near-term.

Coronavirus has to be contained for market stability

For the stock market to reenter a stable re-accumulation phase, the coronavirus outbreak in the U.S.  has to be contained.

Scientists foresee the coronavirus pandemic peaking over June to August, as the summer heat decreases the strength of the virus .

But, unlike China, the U.S. is not able to take extreme precautionary measures to stop the virus from spreading in a short period of time.

For that reason, the recovery from the coronavirus pandemic in the U.S. could be delayed by several weeks.

The stock market resuming a bull market trend—a 20 percent upsurge from recent lows—at a time wherein uncertainty towards coronavirus is heading towards its peak is not fundamentally driven.