This article is written exclusively for investing.com
The markets have been on a steady rise since the lows in March. The bull story has shifted over the months from Fed liquidity to low interest rates, hopes for vaccines and stimulus packages. Regardless of the story, it seems that stocks have always found a reason to rally.
The major problem facing the market while waiting for the potential vaccines to be distributed is a slowing economy. The latter and would indicate that the pace of the recovery is slowing, potentially bringing the market rally to a halt. With a second stimulus deal unlikely in the short term, the Fed's balance sheet is no longer expanding. The market may feel forgotten, resulting in a tantrum to get what it needs to move up further.
A Meltdown
A tantrum is likely to result in a sharp fall in stock prices, helping to motivate a policy response to a slowing economy or increasing fear of a doubling. -dip recession. So far, Congress has failed to agree on a second stimulus deal. Meanwhile, the Fed will not meet until mid-December.
It appears that a tantrum is the preferred method for the market to get its way. Sharp and unexpected shots always catch the attention of policymakers, who are quick to try to calm the emotions of the market. The fall 2018 sell-off was due to the market being nervous about the Fed's too much tightening. Meanwhile, the coronavirus collapse eased in spring 2020 as the Fed agreed to provide adequate liquidity to the market and Congress issued a historic fiscal policy response.
Market is already too big
While it is almost impossible to predict when such a tantrum will come, there may already be signs that the market is overheating and is ready for a new story. Trading has been relatively flat since the beginning of September, while the price is falling. Still, the number of stocks above their 200-day moving average in the S&P 500 was as high as 88% on Nov. 18, a level not recorded since mid-2014. It is a level related to a decline in the stock index.
In addition, inflation expectations have started to diverge from the stock market in recent weeks. The 5-year outlook has declined, while the S&P 500 has continued to rise. Lower expectations could indicate that the bond market is picking up on this slowing economic recovery.
5-Year Outlook for Inflation
A Catalyst
The Fed will meet on December 15th, which could serve as a catalyst event for the wider stock market . If the Fed suggests that the pace of asset purchases will not pick up if the economy weakens further, the market may be unhappy.
The S&P 500 stands alone and will have a hard time because index ratings are already very high. Without the support of an incentive or further easing, the PE ratio could shrink, causing the value of the S&P 500 to fall.
While it is perfectly possible for the stock market to continue the rally as usual, it will likely take some narrative to move up from here. The only story left at this point is the hope of a global economic recovery. But that will likely be slow as it will take time for a vaccine to be distributed worldwide.
Once that happens, investors can turn their attention to an improving world economy, allowing stocks to trade on fundamentals rather than hopes and dreams. Until that happens, this bull market needs a story, and soon, to avoid seeing another of its typical tantrums, we've all come to know and love.
