US futures are set to pierce their ceilings as the Dow Jones futures are trading higher more than 700 points. The fresh optimism is fueled on the back of two factors: firstly, Donald Trump’s announcement of partial opening of the economy and finally, Gilead Science has found more effective results in treating the coronavirus patients. Traders have completely turned a blind eye to Chinese GDP data.
Historic numbers were recorded over in China—the second biggest economy in the world. The Chinese GDP data fell off a cliff and it confirmed that the Chinese economy is off the rail. Its GDP plunged 6.8%, the worst reading since 1992. Moreover, retail sales dropped 15.8% providing a clear indication that consumers have closed their wallets.
There is no doubt that there is a complete disconnect between the fundamental data and the global equity markets. For instance, if we look at the US equity markets, you can see the V-shape recovery, most of the major indices are trading up more than 20% from their COVID-19 low. However, the economic data is breathing on the oxygen tank.
One needs to pay attention to this important factor that we are not close enough to find a bottom in the economic numbers. They are consistently falling and the global economic data print is likely to show adverse reading before anything gets better.
Even when we do find a bottom in these economic numbers, it is highly likely that the recovery is going to be U-shaped or L-shaped. These numbers are not likely to shoot straight up. The chances of V-shape are minuscule, and one can never discount that.
However, one element is for certain that the equity markets have gone well ahead of themselves and the consistency of giving free-passes to economic numbers is going to bite investors.
In addition to this, we are in the middle of the earnings season, and if we have learned anything from Wall Street giants such as Goldman Sachs, Bank of America and JP Morgan, it is that these banks have increased their provision of debt loans—meaning they are expecting higher defaults. Although governments have put measures in place to help small and medium-sized businesses, the reality is that most of the businesses are still failing to acquire any funding because of the strict criteria. The liquidity trap is there, and it is going to choke business owners. As a result, we are likely to see higher default rates.
Another important factor to take into account is that the oil industry is on its knees; the WTI crude oil prices below $25 is bound to open the can of worms—meaning higher default rates. Some of the energy companies such as Chesapeake energy are already sitting on the verge of bankruptcy. My question is have the equity markets factored that in or have these markets been given a get-out-of-jail card?
Perhaps, this is the reason that we are not seeing any significant drop in the volatility index and it’s still very much holding its ground. If we look at other safe-haven assets, such as gold, the gains are solid there as well, and it is highly likely that the prices are going to continue their journey to the upside–the only resistance level that matters the most for gold prices is the $2K mark. (More on how to trade gold)
The bottom line is that equity markets have got ahead of themselves, and have lost connection with reality. Yes, I agree that most of the countries are about to see their Coronavirus peak, but massive damage has been done to the economy during this time period. Until and unless we see a bottom forming in the economic numbers, any rise in the equity markets is prone to some serious risk.