Monday’s madness, is the US stock recovery for real?

There are multiple drivers of financial markets this week. After a torrid end to last week, European stocks remained burdened by bad news including an extension of China’s Covid lockdowns this time centred on Beijing, the prospect of aggressive central bank tightening from the Federal Reserve and the ECB, along with continued concerns about the war in Ukraine and inflation. Amid all this, Elon Musk has won the battle with the Twitter board and has acquired the company for $44bn. As we were writing, there was one comment on this deal that stuck out in reference to Musk financing the deal with a portion of his own Tesla stake: why trade caviar for New York City hotdog? While Musk might say that it is all for the greater good of freedom of speech, this deal, along with a haven bond market rally, helped US stocks to recover on Monday afternoon. Is the stage set for a prolonged recovery rally, or are there too many headwinds to boost markets in the long term? 

The Fed put 

In the years post the financial crisis the markets have become complacent assuming that the Fed will always be the buyer of last resort and thus there was only so far financial markets, and stocks markets, could fall. Likewise, there was only so much upside for bond yields/ downside for bond prices because the Fed was always on the side-lines with a liquidity cushion for when things became a bit too hairy. Alas, that was the Fed of old, the Fed of Ben Bernanke. Under Jerome Powell the Fed has no such cushion, in fact Jerome Powell is going to be squeezing the life out of that liquidity cushion in the coming months, as the Fed rushes to normalise interest rates and shrink its balance sheet. There is now a near 100% chance of a 50-basis point hike at the FOMC meeting next week. There is also an 80% chance that the FOMC will hike rates by another 50 basis points at both the June and July meetings. The Fed is focussed on fighting inflation, and no longer playing the part of Mr Nice Guy. Thus, this is a long-winded way of saying that we don’t think that the rally will last and there remains significant downside risks for the performance of equities this week. 

Analysing the drivers of a stronger US stock market 

On Monday, the S&P 500 jumped in the afternoon session after bouncing off support at 4,200. The rally was broad based, although growth stocks outperformed value stocks. Social media, semiconductors, software, pharma, and retail were all higher, while airlines, utilities and energy were the laggards. Whilst there was no single catalyst that saw US stocks bounce in the late US session, the reasons that stocks were upbeat could have been down to a few factors: 

1, the market is already pricing in an aggressive pace of tightening from the Federal Reserve, including 3 consecutive 50 basis point hikes, as we mention above. 

2, Q1 earnings continue to come in above expectations. On Friday, with 20% of the S&P 500 having reported results, nearly 80% have reported a positive EPS surprise, while nearly 70% have reported a positive revenue surprise. This is good news in what is undeniably a challenging economic environment for many sectors. So far, the fact only 4 companies have reported a positive outlook for Q2 isn’t spooking the markets too much. 

3, US Consumer indicators remain resilient. 

4, Dealmaking is back. 

5, Positioning may also be boosting stocks, as sentiment indicators could have bottomed out. 

The M&A boom is back 

The news that Elon Musk had successfully bought Twitter after a U-turn by the Twitter board, sent the Twitter share price soaring, although Tesla’s share price fell a touch by 0.7%. This high-profile deal stole the limelight, but there are other deals out there worth keeping an eye on, including Match Group. The online dating conglomerate saw its stock price rise nearly 7% on Monday after rumours circulated that it could be a takeover target. Surely, we can avoid a recession if dealmaking is back on the cards? 

For the week ahead…

This week it is worth watching US durable goods, pending and new home sales, the US home price index, April’s CPI estimate for the Eurozone, the prelim US Q1 GDP data and rounding off the week with Eurozone GDP for Q1. It’s also worth keeping an eye on GBP/USD, which sold off sharply last week and lost its $1.30 handle. As risk sentiment improved in the US session GBP clawed back some losses, however, it couldn’t hold onto gains around the $1.2750 mark, and there were further declines late on Monday. This could set this pair up for a further drop back to $1.26-1.2620, the low from July 2020, in the coming days as the pound’s decline has been swift so far and there is currently nothing to suggest that the sell off will slow down.