U.S. stocks this week brushed off headwinds that in the past would have interrupted a rally to near records. That has been the story for a while, reflecting the persistent power of liquidity-driven technicals. What is more noteworthy, however, is how this process has played out.
The latest move up in stocks has pushed the S&P 500 Index and the Nasdaq close to record highs, the Dow Jones Industrial Average to nearly break-even for the year and global stock indexes into positive territory. This has occurred despite the continued stalemate in Congress over a new coronavirus relief bill as well as evidence of a leveling off in the economic recovery, including from the Weekly Economic Index calculated by the New York Federal Reserve Bank.
Stocks’ ability to shrug off unfavorable economic and policy news is not new. In fact, it has been one of the most distinguishing features of a market strongly conditioned to expect ample liquidity support from central banks. What’s perhaps more instructive is how investors alternated themes and positioning this week to drive the market higher.
Think of it as a pendulum. Early in the week, investors bet on the lagging stocks that would benefit from economic reopening. The result was a notable outperformance by the Dow, which has lagged the gain in the Nasdaq by an eye-popping 25 percentage points so far this year (losing 2.25% compared with a gain of 23.07%). In the past couple of days, however, they swung back to something that has been much more familiar to them — stay-at-home tech stocks that they view as offering both an upside potential and downside protection because of huge cash balances and positive cash flows for some of the most influential companies. That includes Apple, which posted yet another record share price on Thursday while also announcing a large bond sale.
This midweek pivot also explains the bounce in gold prices after an earlier dip. The precious metal is attracting a growing portion of risk-mitigation flows away from U.S. government bonds. As a result, gold prices rose on Thursday while government bond prices fell. At 0.72% and 56 basis points respectively, the 10-year yield and the 2s-10s yield curve are back at levels last seen a couple of months ago in the midst of what proved to be the market’s temporary embrace of a sharp V-shaped economic recovery.
As long as the confidence in ample liquidity is unshaken — and it takes a lot to shake markets out of a behavior pattern that has proved time and again to be extremely lucrative — investors will be tempted to buy the price dips. How they do so on the pendulum will continue to be influenced by perceptions of how well the economic and health emergencies are being managed.
The generalized march up in stock prices that results over time from this attracts more retail investors and sidelines those institutional investors that are more inclined to fade or even short the rally. It also increases the underlying longer-term bet that markets are placing on an eventual handoff from heavy reliance on liquidity technicals to broader-based support that comes from improving corporate and economic fundamentals. After all, favorable technicals are necessary to sustain an impressive market rally, but their ability to remain sufficient becomes more in doubt with time the more valuations decouple from economic and corporate realities. And just like the big downturns, the inclination of markets will be to overshoot on the upside, waiting for unambiguous evidence that technicals are indeed fizzling out.
Mohamed A. El-Erian is a Bloomberg Opinion columnist. He is the chief economic adviser at Allianz SE, the parent company of Pimco, where he served as CEO and co-CIO. He is president-elect of Queens' College, Cambridge, senior adviser at Gramercy and professor of practice at Wharton. His books include 'The Only Game in Town' and 'When Markets Collide.'
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