"Expert Take" banner over stock charts and stethoscope

What a difference a week makes. The S&P 500 climbed 18% in a three-day winning streak, breaking a 28-day drought without back-to-back gains (one of its longest in recent memory). The conversation on Wall Street shifted dramatically, investors went from fearing the bottom was far away to wondering how quickly the economy can return to normal. Now, the S&P 500 has inched within 5% of a new bull market.

S&P 500 Chart shows sock movements trending from 1995-2020. Chart shows sharp dips in 2008 and 2020 but overall upward trend.

In our view, we’re not out of the woods yet. There’s a long list of issues for investors to consider, and market sentiment is stuck in a tug-of-war between heightened uncertainty and optimism that this crisis could blow over soon. Still, we’re noticing a gradual shift in the market’s mood, and there are some signs a bottoming process may have begun:

  • Fiscal stimulus is (finally) here. A key driver of the mood shift was fiscal stimulus. On Friday, U.S. lawmakers agreed on a $2 trillion stimulus package — about 10% of U.S. total gross domestic product (GDP). Approximately half of the package would benefit individuals through direct checks and bolstered unemployment insurance, while the other half would support businesses and hospitals. Fiscal policy is an important tool in the recovery process, because it provides aid targeted specifically to U.S. consumers. Consumer spending accounts for about 70% of gross domestic product, and the economy is now facing lost jobs and coronavirus fears. As such, spending could be significantly dented, making fiscal measures an especially powerful tool at this time.
  • The Federal Reserve Board (Fed) is showing up. The Fed has been extraordinarily proactive so far, with policymakers enacting a wide range of measures to stabilize markets. In the past month, the Fed has cut interest rates to zero, opened an emergency lending window for banks, and committed to injecting trillions of dollars into several different markets. Lower rates could help encourage consumers to borrow, and the Fed’s credit facilities should help soften the economic blow for U.S. businesses.
  • Improvement in credit markets. The Fed’s efforts have also helped credit markets return to functioning efficiently. One sign of credit market stress has been the spread between high yield (riskier) and investment grade (safer) yields and the U.S. Treasury yield. Those spreads eased sharply this week after peaking on Monday, a sign that credit is becoming easier for companies to access again. Credit needs to flow to companies and people for the economy to operate smoothly.
  • Market breadth is improving. One way we measure market health is through breadth, or a gauge of how many stocks are participating in each move up or down. Fewer stocks have made 52-week lows this week (compared to weeks prior), showing that swaths of the market are beginning to turn upwards. Cyclical sectors like technology and semiconductors are leading sector gains, showing us investors are willing to put money into businesses dependent on the economic outlook. Remember, stocks are a “leading indicator” for the economy, so we expect the market to bottom before the headlines and economic data.
  • Green shoots in China. Businesses are reopening and people are going back to work in China, a sign that life and economic activity is returning to normal after the coronavirus. In the past few weeks, global companies like Starbucks and Nike discussed how their stores are reopening in China. This week, Hasbro said they would be operating at full capacity in China by the end of the week, and Micron said they are seeing more manufacturers in China return to full production.
  • Social distancing may be working. The coronavirus has had a devastating human impact around the world, one that fiscal and monetary policy can’t fix. However, health policy has come a long way in the past few weeks, and the U.S. has implemented serious measures of social distancing and shutdowns to contain the spread.

Watch out for the “head fake.”

To be sure, this latest rally may just be a bull market “head fake.” Economic data is deteriorating quickly, and we still have few signs on just how severe the economic impact will be. Just this week, initial jobless claims soared to a record 3.3 million (from 281,000 last week), and gauges of manufacturing and services pointed toward an economic downturn. Earnings estimates are falling, and many companies are completely withdrawing guidance, making it tougher for investors to predict how low profits could go. Investors are bracing for more downside, evidenced by the CBOE Volatility Index (VIX) still near 11-year highs.

“Head fakes” have been common in past bear markets. In the last bear market, the S&P 500 notched a six-day, 18% rally in October 2008 and a five-day, 19% rally in November 2008 before finally reaching the bottom in March 2009. However, while the road ahead may still be bumpy, we think bounces like these are the first steps in stocks ultimately finding a bottom. Bear market pullbacks that bottom quickly typically recover quickly as well, according to CFRA data.

The length of this bear market will be closely tied to the depth and length of the slowdown in economic activity. The economy’s response will largely be dependent on how quickly the government can get the aid to those the most in need, and how effectively we can get the health care crisis under control domestically.

What do I do now?

If you’re a long-term investor, it might be best to sit tight and not make any rash decisions. Stock prices are still near multi-year lows, so it also may be a good time to buy in. However, it’s difficult to know what the market will do next, so we’d encourage long-term investors to tune out the daily moves and focus on their investing goals and risk tolerance. It may make sense for investors with shorter-term goals to consider safer assets, like fixed income, in case stocks turn again. Seasons change, even in the stock market.

The opinions expressed here are not meant to be used as investing advice. For more information, visit our website.
 

Speech bubble icon next to text "Expert Take"

Headshot of Lindsey BellLindsey Bell is Ally’s Chief Investment Strategist, responsible for shaping the company’s point of view on investing and the global markets. She is also President of Ally Invest Advisors, responsible for its robo advisory offerings. Lindsey has a broad background in finance, with experience on the buy-side and sell-side, in research and in investment banking and has held roles at JPMorgan, Deutsche Bank, Jefferies, and CFRA Research.

Lindsey holds a passion for teaching individuals how to become successful long-term investors. She frequently shares her knowledge as a guest on national news outlets such as CNBC, CNN, Fox Business News, and Bloomberg News. She also serves on the board of Better Investing, a non-profit organization focused on investment education.