At the end of last week, it looked like the equity market pullback that everyone had been expecting was finally beginning to materialize. However, at a time when corporate and economic fundamentals are weak, and expected to remain impaired for the foreseeable future, investors are increasingly taking their cues from the macro data. As we have touched on in prior posts, investors seem focused on three things: the rate of COVID-19 case growth, the policy response and the potential for a strong rebound in corporate profits over the coming 18 months. When viewed through this lens, the equity rally that we have seen begins to make a bit more sense.

On the data front, markets are focused on rate of change, rather than absolute levels. That is all well and good when the data is improving, but it is important to recognize that there are limits to how long this can continue. Until we have a vaccine, there will be a limit to how much the economy is able to re-open; as a result, the pace of improvement will gradually slow, and markets will shift their focus to the level of the data, rather than the direction. Take the May retail sales report as an example; markets cheered the 17.2% m/m increase in sales, but ignored the fact that the level remains more than 8% below the January/February average. Furthermore, if we assume monthly retail sales growth is in line with its 10-year average going forward, we will not surpass the January/February average until October 2022.

On the policy side, the taps are open and stimulus is flowing. Last week saw the Federal Reserve (Fed) suggest that policy rates will remain at the zero bound through 2022, and the beginning of this week saw them commit to purchasing corporate bonds in the secondary market. On the fiscal side, there is a clear expectation that the bazooka will be fired again; this will likely extend unemployment benefits through the end of the year, and preliminary reports suggest that an infrastructure package is also being discussed.

So the stars seem to be aligned – the data is getting better, policy on all fronts is accommodative and case growth remains under control. While a second wave of infection or removal of policy supports would cause markets to pull back, it is unclear whether either of those will materialize in the near-term. As such, we remain focused on the ability of the economic data to continue surprising to the upside, and would expect that as things cool off in the coming months, markets will begin to focus on the challenges facing the economy going forward. While we do not think this would precipitate a re-test of the March lows, we do believe that volatility will persist through year-end.

Oh, and don’t forget about the November election...

Case growth, economic activity, policy stimulus and the stock market

S&P 500 index, average z-score of U.S. COVID-19 case growth, “stimulus” story count and Citi Economic Surprise Index

Source: Bloomberg, Citi, Johns Hopkins University, Standard & Poor’s, J.P. Morgan Asset Management. Story count is a 7-day moving average. U.S. COVID-19 case growth is the 7-day changes in the 7-day moving average.

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