Are investors optimistic or plain ignorant?

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In an astonishing display of resilience, the S&P 500 index of US blue-chip stocks has defied every bearish prognostication and rebounded to just 10 per cent below the record high reached in February. Now, even analysts at Goldman Sachs, who predicted last month that the index could plunge 18% by the end of summer, have since quickly revised their forecast, lifting downside targets for the index.

What is driving this rally of the equity and debt markets in recent weeks? Two key players. The Federal Reserve and bullish investors.

Doing everything possible to eliminate the threat of a financial crisis, the Fed has unleashed multi-trillion lending facilities, creating a floor under asset prices and stimulating the U.S. economy as it re-opens. However, the buoyant market stands in huge contrast to the onslaught of bleak economic news. Are investors turning a blind eye to the fact that 40 million Americans have filed for unemployment benefits? What about news that major airlines on both sides of the Atlantic are cutting tens of thousands of workers?

Unfortunately, this highlights what many see as a glaring disconnect between Wall Street and Main Street.

This disconnect is further evidence that investor optimism has been blindly led by aggressive financial stimulus policies and the prospect of swift economic recovery once lockdowns and other restrictions are lifted. On the back of the recent rally, many market skeptics are warning that the behaviour of bullish investors are being fuelled by over-confidence that a vaccine will emerge soon and somehow lead to a magical rekindling of corporate profits in the near future. This is despite warnings from top scientists that a vaccine may not be available as soon as expected and that economy re-openings could trigger second wave outbreaks that could lead to more lockdowns and further hamper the road to recovery.

Yet so far, sustained buying has proved doubters wrong. New believers of optimism continue to hope on the bandwagon due to ‘fear of missing out’ (FOMO), all hoping to seek momentum from the recent rally.

Ever since lockdowns were first imposed, brokerages have already been reporting a sharp increase in new account openings to buy stocks, causing one to wonder if these are indeed signs of optimism, or perhaps of boredom. The ease of online trading and a widespread “buy-the-dip” mentality have all contributed in attracting a new breed of retail investors. As for asset managers, who have fiduciary duties to invest, many are also under immense pressure to buy shares, especially when yields from cash or debt is zero.

Despite the wave of FOMO investors and recent rebound, major risks remain, lurking at every corner of the market. Any negative surprises post-lockdown or an ugly second wave of infections could send asset values plummeting without warning.

With many unknowns and uncertainty, FOMO investors who are chasing for profits are indeed pretty aggressive. However, those priming for another big sell-off may have to wait, as U.S. policymakers are supplying markets with confidence through their commitment to expand and extend record amounts of fiscal and monetary support.

At this juncture, I believe it is now challenging for small twists to turn the market, but a major event will do the trick. Such as the crisis of commercial real estate, corporate or consuming lending that is critical to banks’ health and will test the ability of central banks to contain matters. Not forgetting the escalating tensions between U.S and China could unsettle markets too.

The rally of US equity market we’ve witnessed over the last few weeks is fuelled by tremendous amounts of assumptions. The impact of the coronavirus to the global economy is at best still at its initial stage, nobody is certain where this crisis will lead the global economy, but for sure, investors must expect many twists and turns to occur along this journey. Current valuations of equities are plausible… But only if the most optimistic assumptions turn out to be accurate…

Stay safe.

– RT

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