Unemployment reached historic highs in the US as a pandemic swept across the globe, and the Standard & Poors 500 shot up like a bullet, briefly topping 2,950 on Wednesday, April 29, 2020.

What happened to Efficient Market Hypothesis?

The global strategy team at JPMorgan told its clients this week:

We believe that a bullish environment in equities and risky markets is underpinned by six factors: liquidity injections; zero cash rates and low bond yields; the presence of an equity short base and equity underweights among investors; the defensive nature of the risky market rally so far; the relaxation of lockdowns and signs of bottoming out in economic expectations; and last but not least the rapid healing of credit markets.

And that seems to be the consensus among investment professionals.

But where does the market go from here? The coronavirus outbreak shows no signs of slowing in the US, but with many states reopening and the recent extraordinary measures taken by the Federal Reserve, investors have continued to pour money into equities.

So the question is what is being priced in to the market? If the market is in fact efficient, what are the investors pricing in to their equities trades?

Benjamin Bowler of Bank of America Global Research suggests that investors are betting on extreme outcomes. “Given the strong relationship between the length of bear markets and that of recessions, equities are either betting on a record short recession (despite forecasts for near the worst in history), or on the Fed buying equities, believing fundamentals don’t matter,” Bowler said.

BOA’s Global Research team, however, is at odds with the bank’s economic research group, which is predicting “the worst recession on record as a result of the forced stoppage in economic activity during the second quarter.”

Based on the April rally, which saw the market gain back half of its historic losses in the month prior, investors are betting that the global economy and social structures are going to be able to weather this unprecedented storm and rally back to pre-coronavirus levels in short order.

Barry Bannister, chief institutional equity strategist at Stifel, who called the April rally acknowledged that another market move will be dependent on “a shock … then (action by) the Fed.”

But the downside risk for the market remains strong. Bannister added that support for the S&P 500 would likely require an upward shift in GDP data for Q3, otherwise down-trending 2021 earnings per share forecasts will be priced in, which would price the market lower.

Or not … maybe depending on what additional extraordinary efforts the Fed and other central banks take to inject cash into the economy. Matt King, the global head of credit strategy at Citigroup acknowledged in a recent report, “The gap between markets and economic data has never been larger.”

When the Fed and Congress inject the equivalent of 1/3 GDP into the economy in a few short weeks, that money has to go somewhere. With that kind of infusion, market fundamentals are out the window. An injection of liquidity into the economy should result in inflation; but without main street businesses operating one possibility is that the inflation from the cash infusion is showing itself in the markets. Further, with interest rates near zero there aren’t really very many places for investors to put their money.

Ultimately, it’s likely that the rise in equity values will turn out to be a bear market rally, if investor optimism fades. And there’s plenty of reason to believe it will. As economic data continues to roll in, it might be hard to ignore. Reports show the economy shrunk by 4.8% in the first quarter and some 30 million people have filed jobless claims. April unemployment numbers will be out at the end of the week (Friday, May 8).

“Beware of the oddity in this bear rally,” Andrew Lapthorne, global head of quantitative research at Societe Generale, recently said in a note to investors. “Given the overall negative undertone from the economic challenges ahead, the dramatic reversal of global markets after the pandemic lows is more puzzling.”

Puzzling, indeed.

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