The rally in equity markets since their late March lows has been tremendous. Despite an unrelenting chorus of doomsayers who like me have worried about the shape of recovery, markets have been impervious to bad news. At the end of last week the May US employment report provided the latest catalyst to boost markets, after the release of data showing a shock 2.5 million increase in non-farm payrolls compared to consensus expectations of a 7.5 million decline. The unemployment rate also surprisingly fell, to 13.3%, compared with 14.7% in April. The data was taken as an indication that the US economy was resuming activity more quickly than expected. As a result, the S&P 500 closed 2.6% higher on the day and almost 5% higher over the week. Another support factor for markets over the week was the European Central Bank’s expansion of its stimulus package, adding a more than expected EUR 600 billion to its asset purchase programme.
The lesson here is to not fight the Fed. While many of us have been looking at fundamentals and surmising that fundamentals do not justify the rally in stocks, the reality is that this rally is not about fundamentals, well at least fundamentals in the traditional sense of the word. The Fed and global central banks have been pumping in vast quantities of liquidity via quantitative easing, and this has led a massive increase in money supply in excess of economic growth. This excess has had to find a home and equities have been such a home. As of last week the S&P 500 recorded its biggest ever 50-day rally, up 37.7% and shows no sign of turning even as forward price/earnings ratios look increasingly stretched and economic activity appears likely to return only slowly, not withstanding the jump in May payrolls.
There are clearly plenty of risks on the horizon as mentioned in my previous blog posts, with a key one being the fraught relationship between the US and China. However, for now markets don’t really care or at least are choosing not to care. What started as a narrowly based risk rally has increasingly drawn in a wider base of investors who have increasingly been caught in what is commonly termed as FOMO or the fear of missing out. This is dangerous to say the least, as it suggests that investors are only jumping on to avoid missing out on the rally rather than due to any fundamental rationale. Nonetheless, the risk of not joining the rally is to miss out on even further potential gains. The rally in risk assets has continued to hurt the dollar, which slid further over the last week, but is looking somewhat oversold based on some technical indicators.
Direction this week will come from the FOMC meeting on Wednesday although it seems unlikely that the Fed will announce anything new. Markets will be particularly watchful for any indication on whether the Fed is moving towards enhancing its forward guidance. In the Eurozone, the Eurogroup meeting will garner attention as Finance Ministers discuss the EU’s proposed Recovery Fund. In Asia, China’s May trade released earlier today data will set the tone for the week. The data revealed that China’s May exports fell less than expected, dropping 3.3% y/y USD terms, while imports dropped much more than expected, falling by 16.7% y/y. Importantly, Chinese imports from the US declined further, highlighting the lack of progress towards the targets set out in the “Phase 1” trade deal.