Why Be Believe This Current Rally is Unsustainable

dow recession s&p500 stocks May 11, 2020

by: Tam Ging Wien

All examples and stocks quoted here in this article and on the ProButterfly.com and REITScreener.com site are for learning purposes; it does NOT constitute financial advice or a Buy/Sell recommendation. Contents are reflective of personal views and readers are responsible for their own investments and are advised to perform their own independent due diligence and take into account their own financial situation. If in any doubt about the investment action you should take, you should consult a professional certified financial adviser. 

After hitting a historical high of 3,386.15 on 12-Feb, the S&P 500 Index made its fastest plunged to a low of 2,237.40 over a span of just 24 trading days. From 12-Feb through to 23-Mar, the S&P 500 Index loss of 33.9% due to fears that the COVID-19 epidemic has worsen around the world. However, following this record plunge, the S&P 500 Index also made a record rally of 30.9% from the 23-Mar lows to the current time of writing – closing at 2,929.80 on 08-May.

In Singapore, the STI similarly plunged from 3,223.37 on 12-Feb to a low of 2,233.48 – a 30.7% plunge through to 23-Mar. At the time of writing, it has since recovered to 2,591.88, a 16.4% gain.

The media has attributed many potential factors for the rapid recovery of the stock market including:

  • Signs that the COVID-19 epidemic is peaking and worldwide efforts to contain the virus is taking effect
  • Confidence that governments and central banks around the world will do what it takes to contain the economic fallout including bailing out corporates and key industries
  • Unprecedented stimulus measures taken by governments and central banks around the world
  • Expectations that providing IRS stimulus payments to Americans will continue to maintain consumer spending
  • Stock markets looking ahead to a better 2H-2020 once various containment and lockdown measures are lifted
  • Stronger than expected PMI and GDP figures coming out of China as it gradually reopens its economy
  • US, European and various other economies are starting to re-open for business again with confidences that the economy will recover quickly
  • Investors seeing immense value in the stock markets after the rapid sell-off rush in to buy driven by bargains and bravery
  • Investors believe that the source of this recession is different from the Global Financial Crisis and expect a V-shaped recovery since this recession is caused by an external virus and not related to fundamental problems in the banking industry
  • Believe that President Trump and the Fed will continue to prop up the stock markets to increase chances of getting re-elected come Nov-2020
  • The stock market is not the economy, the stock markets look forward and seeing through all the doom and gloom for a brighter outlook in the coming quarters

While we can appreciate the various reasons given for the rapid rally witnessed in the last 7 weeks, we think that at this juncture, we would rather stay on the side-lines be patient to observe if the markets will retest the 23-Mar lows.

Let’s us share our reasoning for our wait-and-see decision which can be segmented into the following 2 parts:

  • Economic Indicators Point to a Recession
  • Technical Analysis Indicators Suggest Continuation of a Downtrend

Economic Indicators Point to a Major Recession

While a recession has not been officially declared in the US, Europe and even in Singapore, from our observation of publicly available information and impact of many of the containment and lockdown measures, many countries will very likely enter into an economic recession in the coming weeks or months.

In a major recessionary scenario, corporate profits are expected to fall or even go into the red. Falling corporate profits will likely also lead on to falling stock prices. We break down some of the leading economic indicators that we are tracking and why we think a recession scenario is on the cards which will in-turn hurt corporate profits.

We will focus on the U.S. though we will mention other major economies simply because we believe that if the U.S. enters a recession, it will drag the rest of the world economy down as well.

Record Unemployment Rate Curtail Consumer Spending  

First, at the end of Apr-2020 unemployment rate rose 3.1% to 15.5% and the unemployed persons rose by 4.6mil to 22.65mil in April due to the impact of the COVID-19 containment measures taking in affect in March and April 2020. But those figures are just the tip of the iceberg as the U.S. Department of Labour released shockingly high weekly initial jobless claims data:

  • Week ending 21-March: 3,283,000
  • Week ending 28-March: 6,648,000
  • Week ending 04-April: 6,606,000
  • Week ending 11-April: 5,245,000
  • Week ending 18-April: 4,442,000
  • Week ending 25-April: 3,846,000
  • Week ending 02-May: 3,169,000

This means that in the last 7 weeks as the stock market rallied, a total of over 33.2mil Americans had filled for unemployment insurance claims for the first time! Based on the latest census data, the U.S. labour force of Americans aged 16-years and older is 164,360,000. Therefore, with over 33.2mil Americans filling from unemployment insurance claims for the first time, we are looking at the unemployment figures possibly jumping to at least 20.2% come end May-2020 assuming the initial jobless claims no longer increases in the coming weeks which is unlikely. At such extremities, the COVID-19 epidemic and containment measures have essentially wiped out all the job gains since the last recession in less than 7 weeks.

These initial jobless claims are expected to stay in the millions for several more weeks to come due to the cascading effects of the COVID-19 containment measures. This is beginning to build into a far worse recession and probably a more difficult recovery once the pandemic subsides, comparatively, the peak unemployment rate in Oct-2009 was 10.0% and 10.8% respectively in Dec-1982.

There are further reports that the unemployment figures reported could be an under-count based on the explanation by as Jeffry Bartash.

At such record levels of unemployment, the ability for American’s to spend and maintain the same economic prosperity is wiped out. According to economic data by the Federal Reserve of St. Louis, U.S. personal consumption expenditure makes up approximately 68.1% of the U.S GDP in 2019. Loss of ability to spend would surely shrink the U.S. corporate and plunge the U.S. economy.

Plunge in the Global PMI Indicating Poorer Corporate Spending  

Forward indicators of the economy such as the Global Purchasing Managers’ Index (PMI) has made record lows. The PMI is based on a monthly survey of supply chain managers in five major areas: new orders, inventory levels, production, supplier deliveries, and employment. The PMI is quoted as a number from 0 to 100. A reading above 50 represents expansion while a reading below represents a contraction when compared to the previous month.

As the name suggest, if the purchasing managers’ are confident and expect increasing orders and business, it would more aggressively purchase raw and semi-finished materials to fulfill those orders. Therefore, the PMI becomes a leading indicator of the economy and the changes in the PMI precede the impact on GDP.

Based on the latest reading, the from JPMorgan’s Global Composite PMI came it at 39.40 for the month of Mar-2020.

Source: Trading Economics

Looking the composite PMI across the major world economics as well as Singapore show a mark contraction:

  • IHS Markit US Composite PMI for Mar-2020: 40.9
  • IHS Markit Eurozone Composite PMI for Mar-2020: 29.7
  • China Caixin China General Composite PMI for Mar-2020: 46.7
  • IHS Markit/CIPS UK Composite PMI for Mar-2020: 36.0
  • Jibun Bank Japan Composite PMI for Mar-2020: 36.2
  • Russian Composite PMI for Mar-2020: 39.50
  • India Composite PMI for Mar-2020: 50.60
  • IHS Markit Singapore PMI for Mar-2020: 33.3

Source: New export orders from purchasing managers indices, Jan. 2008 – Mar. 2020, IHS MarkitWorld Trade Organisation

Many of the PMI figures listed above are at historical lows, lower than during the 2008/09 Global Financial Crisis. These figures certainly paint a very bleak picture of the global economic in the coming quarters.

Plunge in the Global Trade and Real GDP Growth

The World Trade Organisation (WTO) forecast that the global trade decline amidst the COVID-19 epidemic will likely exceed the trade slump brought on by the global financial crisis of 2008‑09. As a result, global trade is expected to fall by between 13% and 32% in 2020 due to the disruption of normal economic activity and life around the world.

The WTO report paints two possible scenarios:

  • optimistic scenario, with a sharp drop in trade followed by a recovery starting in the second half of 2020
  • pessimistic scenario, with a steeper initial decline and a more prolonged and incomplete recovery

Under the optimistic scenario, the recovery will be strong enough to bring trade close to its pre-pandemic trend, represented by the dotted yellow line in the chart below, while the pessimistic scenario only envisages a partial recovery. Under both scenarios, all regions will suffer double-digit declines in exports and imports in 2020, except for “Other regions” (which is comprised of Africa, Middle East and Commonwealth of Independent States (CIS) including associate and former member States).

For more information, we recommend that you consult the full report by the WTO at the following link:

Source: World merchandise trade volume, 20002022, World Trade Organisation

Further, the International Monetary Fund (IMF) projected a negative economic growth across the globe with only China and India narrowly escaping negative real GDP growth in 2020. On a brighter note, real GDP projections for 2021 is expected to be positive globally as they expect economies to regain normalcy. 

Source: World Economic Outlook Projections, April 2020, International Monetary Fund (IMF)

Ultra-Low Interest Rates Squeeze Retail Bank’s Margins

A retail bank generates its revenue from the collection of deposits and paying out low short-term interest rates and in turn using those deposits to make long-term loans with higher interest rates. In short, banks profit from the difference between the yield they generate on the loans against the interest they pay out to its depositors. This difference is known as the bank’s net interest margins (NIMs).

While going about this fundamental business, banks are required to keep on hand a certain amount of the cash to fulfil short-term withdrawal request but are not required to maintain the entire amount on hand. This is known as the fractional reserve banking system.

Generally speaking, the interest that banks pay to depositors are already very low and are insensitive to monetary policy settings. If interest rates fall, the interest on the loans provided will also fall compressing the lending margins resulting is lower NIMs.

The central banks around the world have been aggressively cutting interest rates in hopes that this will drop the cost of lending enough in order to:

  • Give a chance to businesses and individuals who are leveraged to reduce their financial burden and forestall retrenchments or bankruptcies
  • Make lending cheap enough that that businesses and individuals will be encouraged to take out loans and expand their business
  • Make deposits so low yielding that they are insignificant that depositors would rather withdraw and take risk investing them or starting new businesses

While the above is the objectives of the central banks, in a recession scenario, assets are in a deflationary state. Which means that despite cash yielding close to zero in a bank, it has buying power is still strengthening as assets get cheaper. This creates a scenario where depositors will continue to hoard money. Even if every citizen is given a sum of money to spend, they will likely hoard it in the bank if assets are deflating or when their own jobs are at risk.

On the other hand, this scenario also creates a situation where bank’s margins are squeezed so tightly that they are reluctant to lend. When this scenario occurs, banks will be more selective in of which business or individuals will be granted a loan or start to call bank loans of borrowers it thinks may be at risk of default. This situation creates a vicious cycle where businesses cannot obtain loans to expand its business while consumers cannot obtain loans to buy large ticket items like properties or vehicles with deep economic value chains which will cause the economic activity to continue to contract in the short-term.

Ultimately, this vicious cycle will reduce economy activity, hurt corporate profits and result in short-term price declines.

 Board of Governors of the Federal Reserve System

In the longer term, these ultra-low interest rates will result in rapid asset price inflation which will result in another asset price bubble forming with the economic cycle repeating itself.

Technical Analysis Indicators Suggest Continuation of a Downtrend

Using several common technical analysis indicators, it hints at a possibility that this rally is unlikely to sustain. We share some of the basic technical analysis indicators that we have observed below referencing the Dow, S&P 500 and the Singapore STI Index charts below.

Source: S&P 500 Index, Investing.com

Source: Dow Jones Industrial Average Index, Investing.com

Source: FTSE Straits Times Index (STI), Investing.com

S&P500 Index Approaching 100-MA and 200-MA Resistance Levels

We have plotted 3 moving average indicators (MA) and we have decided to pick the 200-day, 100-day and 50-day moving averages which roughly corresponds to the yearly, half-yearly and quarterly average periods which we will term as the long-term, medium-term and short-term moving averages (MA).

In all 3 MAs, we observe that they are all pointing downwards which hints at a bearish market.

At the point of writing with the S&P500 Index closing on 08-May, we see that the index is approaching the 100-MA and 200-MA lines which could be viewed a potential resistance levels. There is a possibility that these moving averages may signal the peak for S&P500 before declining again.

Falling Trading Volumes as the Markets Rallied

Over the last seven weeks that the market has rallied, trading volumes appear to be on the decline which potentially indicates that the buying pressure has weakened. This may indicate that buyers are being exhausted as the rally continues, fewer and fewer investors are chasing the rallies. Without buyers, it would be difficult for the market to continue its upward trajectory. This can be observed in both the Dow and the STI. 

Index Reached Critical Fibonacci Retracement Levels

A Fibonacci retracement is created by taking two extreme points on a stock chart and dividing the vertical distance by the key Fibonacci ratios of 0.0%, 23.6%, 38.2%, 50.0%, 61.8%, 78.6% and 100%. The 3 critical levels most often observed are the 38.2%, 50.0% and 61.8%.

The Fibonacci sequence of numbers starts with 0 and 1 and then followed by the sum of the 2 preceding numbers: 0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233…etc.

The key Fibonacci ratio of 61.8% is found by dividing one number in the series by the number that follows it. For example, 89 divided by 144 equals 0.6181 and 144 divided by 233 equals 0.6180. The 38.2% ratio is found by dividing one number in the series by the number that is found two places to the right. For example, 89 divided by 233 equals 0.3820.

This ratio also known as the Golden Ratio or mathematically known as Phi appears naturally in nature fairly regularly. Examples include the branching in trees, arrangement of leaves on a stem, the fruitlets of a pineapple, the flowering of artichoke, an uncurling fern and the arrangement of a pine-cone. For more information on the Golden Ratio and its occurrence in nature, do see the following links:

Proponents of the technical analysis using the Fibonacci Retracement Levels argue that the herd mentality of the stock market participants tend to also behave in these ratios naturally. Therefore, these levels become critical in technical analysis when supported by other indicators and macro-economics.

Both the Dow at the S&P 500 is presently flirting at the 50.0% level while the STI is currently hanging on the 38.2% level. These are viewed as critical levels as price directions tend to change upon reaching these levels. A regular occurrence in nature or a self-fulfilling prophecy? We leave that to the reader to decide.

Back to the technical levels, based on the moving average indicators pointing downwards, declining volume, emergence of a death cross and coupled with a high probability of a recession, we are inclined to think that 2 possible scenarios may playout in the Dow and S&P 500:

  • The rally continues for another couple of weeks and the indexes hit the 61.8% levels before reversal
  • The rally runs out of steam at the 50.0% level and begins to reverse downwards

Either scenario above suggest that investors should not chase these rallies as the upside gain is not worth the downside risk.

Tech Giants Are the Only Bright Spot

The S&P500 appears to be the strongest of all, lead by the top 5 tech heavyweights of Microsoft, Apple, Amazon.com, Facebook and Alphabet (Google). The combined weight of all these 5 tech giants contribute 20.87% of the S&P500. If we were to look at the top-30 components of the S&P500, 25.72% would be made up to tech heavyweights such as Intel, Netflix, NVIDIA, Adobe, Cisco and PayPal. Going on further into the top-100, tech stocks make up nearly 28.47% of the S&P500. The entire S&P500 is weighted approximately 30.3% to the tech sector.

Compared to the Dow Jones Industrial Average (Dow30), tech heavyweights make up only 20.3% of the entire Dow30. Due to the smaller weightage of the tech sector, the Dow30 did not retrace all the way back to the 61.8% Fibonacci Level compared to the S&P500. Dow30 is mid-way between the 50.0% and the 61.8% Fibonacci Levels.

The STI fared the worse with hardly any tech stocks within its components, the STI is more heavily weighted toward the Banking, Telco and Real Estate sector. It is presently hovering only at the 38.2% Fibonacci Levels.

This indicates to us that the general markets are far more depressed that the S&P500 index seems to imply.

What Could Investors Do in Such Uncertain Times?

If we summarise what we have learnt and observed from historical bear markets, we ourselves would follow these investing rules for during these current uncertain times:

  • Judging by previous stock market crashes, we are still early in the a much longer and more painful roller-coaster ride with many ups and downs.
  • Do not rush into the markets and chase rallies, instead wait for 23-Mar-2020 lows to be tested and new lows to form in the coming 4 to 8 months
  • Keep an eye on the declines to the 45% to 55% level
  • Keep an eye on the emergence of a “horse-hoof” pattern
  • Do not be fooled by the current bear market rallies which are likely to be temporary before seeing new lows
  • Prepare a watchlist of stocks which are fundamentally strong and target prices and be patient for the opportunity to pick them up at right prices
  • Hoping that a losing stock will recover is not a good strategy, instead take advantage of the current rally and exit positions that you are not comfortable holding during these uncertain times, better to cut losses during a rally than to sit through another bout of decline
  • Remember that every stock market crash is unique onto its own, while familiar patterns may emerge over and over, every single crash has its own unique characteristics
  • Do not try to time the market lows, be patient for the end-of-decline signs to appear

No one knows the severity of the COVID-19 situation and how it may play out as this is an unprecedented situation in modern history. We could emerge from Q2-2020 better and stronger with the virus under control and Q3-2020 would start to look rosy again. Or perhaps we could find ourselves in another lockdown in Q3-2020 due to a resurgence of the virus as the current containment measures were insufficient leading to further declines in the stock market.

If we could conclude a final rule for ourselves, it would be that we should stop trying to search for an answer that nobody can give us about the future. Instead, we will need to take time and patience to ease into the markets and consider deploying a small portion of our capital at each successive low after first hitting our 55% decline mark after new lows have formed below the 23-Mar-2020 lows. This roughly corresponds to the 1800 to 1910 range in the S&P 500. If the market declines further, ensure that we have the capital to progressively average down.


We are on the opinion that this is not likely to be a v-shaped recovery in the markets but more likely to be a temporary rally in the broader bear market decline which could last anywhere from 6 months to a 15 months from the peak of 19-Feb-2020. We offer 2 key reasons for this:

  • Major economic indicators such as unemployment rates, global PMI, gold/copper ratio spike, severity of containment measures on businesses, decline in global trading volume and historically low interest rates to point toward a worldwide recession
  • Basic technical analysis indicators suggest a continuation of the downtrend including moving averages crossing downwards, bearish death cross, declining trading volumes and current markets at key Fibonacci reversal levels

We acknowledge that each reason and indicators (e.g. low interest rates, contraction in global PMI, gold/copper ratio spike, death cross, Fibonacci reversals…etc) stated above when taken individually does not guarantee that the stock market decline will develop into a bear market. However, when the technical analysis is taken together with the macro-economic data and observations of past stock market crash patterns, we are on the strong opinion that there is a high probability that we will retest the 23-Mar-2020 lows in the coming weeks to months.

We also acknowledge that this COVID-19 stock market crash is unprecedented, and no amount of analysis or models can possibly predict with a high degree of certainly to what the future will hold. Many scenarios could play out including bringing the virus under control in Q2-2020 or see a resurgence of the virus in Q3-2020 resulting in renewed containment measure hurting the economy further.

We don’t have a crystal ball into the future and therefore instead of trying to predict the future, we instead shall reminder ourselves to remain calm and levelheaded during this period and follow our investing rules that we have set out above for ourselves in a logical and disciplined manner.

As I complete this piece, I still have nagging thought in my head that bugs me. Perhaps my past knowledge and experience had not prepared me for this. Perhaps the markets know and understand something that I don’t. Perhaps it was just foolish of me to bet against the Fed and central banks pumping money into the markets. Perhaps I have been completely wrong in all the analysis above and misread this whole incident as a bear market when it is really is just a correction in a bigger and longer bull market.

Perhaps this time it really is different? If so, I might one day look back and regret this worse investing decision of mine – not investing in the Spring of 2020.

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