The stock market continued its negative momentum that I highlighted last week, and in quite a sharp way, but to start November staged a rebound, and then a sharp rally the day after the election.
A key level to watch is whether the market holds this potential support level of the September low point from a little over a month ago (a “double bottom”), or whether it breaks down into a lower low, which would continue the downward momentum.
Rising coronavirus hospitalizations in both Europe and the United States (but not really in Asia), as well as continued gridlock on stimulus, have put plenty of downward pressure on risk assets.
An Unusual Week
Usually, when stocks fall, long-duration bonds go up, meaning that their yields go down. This is because investors shift from stocks to bonds, and the bond market starts pricing in a more disinflationary outlook, meaning lower yields.
However, October 28th was the first day since March where stocks fell at least 3.5%, and bonds also fell (their yields went up), and gold also went down. In other words, both types of defensive assets sold off along with a sharp stock decline.
The last time we saw a day like that was during the liquidation event in March, and before that, we have to go back to 2008 to find similar days of sharp stock declines and defensive assets also going down.
This suggests a minor version of a forced liquidation sale, rather than a typical disinflation trade.
And although October 28 was the key liquidation day, it wasn’t just a one-day event with a quick bounce-back. Stocks, long-duration Treasuries, and gold all finished last week at lower levels than they started the week.
The recent liquidation-style sale basically suggests that there is a rising solvency issue under the surface, in a no-stimulus environment as we have currently.
This week, though, stocks rallied in the two days leading up to the election and in a big way the day after. It remains to be seen if that is a start of a meaningful uptrend, or a small bounce that runs into a “sell the news” event when we have some election certainty.
The good news, reported last week, was that a sharp GDP bounce back occurred in Q3, 2020 as expected:
However, GDP still remains well below the previous high. Going forward, the Atlanta Fed’s GDPNow estimate, which takes into account current data as they come in, suggests a moderate 3.4% annualized real GDP growth rate for Q4:
This will change over time as new data come in, potentially up or down, but overall shows that the fast GDP bounce-back is over, and now it’s a grind to get the rest of the economic output gap back.
This mostly mirrors what we saw in 2008:
Compared to that event in 2008, the GDP decline was deeper and sharper in 2020 due to the unique nature of the pandemic, but even as the economy recovers, it doesn’t fully get back to the growth trend that it was on before the recession began, and creates an output gap.