Stocks Take A Breather from Rally, Where To From Here?

With many eyebrows being raised across the board as equities caught what’s being called a blow-off rally during May and the start of June, it’s no surprise that they’ve cooled a little as profits are taken and risk is reassessed.

The narrative turned from the bounce off March’s lows being nothing but a dead cat bounce to one of it being a full recovery rally as restrictions started to be rolled back in May. The worst of the economists’ fears hadn’t come to pass and there was a consistent trickle of promising economic data being released.

The last semi-serious pullback by the benchmark S&P 500 index (SPX) was around the middle of May when it came off about 6% over three sessions. In the three weeks through the start of last week, it then rallied and took out the previous post-COVID highs as it logged a startling 17% run, no mean feat for the world’s most-watched index. Around the same time, we saw speculative bids flooding back into risk-on industries like tech and individual stocks like Nikola (NASDAQ: NKLA) and Hertz (NYSE: HTZ).

Bullish on Bankruptcies

The beleaguered Hertz rallying 500% and issuing fresh stock while going bankrupt was a canary in the coal mine for many, in the short term at least. Since the highs of last week, the S&P 500 has had its worst day since March and the Dow Jones Industrial Average index (DJIA) has seen a daily drop of 1,800 points. These kinds of swings were a daily occurrence during the initial onslaught of COVID-19 in March and will be welcomed back by few on Wall Street.

Through the end of last week, the major indices had fallen about 7% as fears of a second wave of coronavirus cases and the potential knock on effects of that increased. The big question for investors now is which way things will swing. Like the aftermath of an earthquake, additional but smaller scale tremors are to be expected as the market finds its feet again and traders adjust their risk parameters.

Fed Doing Its Part

The Federal Reserve is doing its part to calm the waters. They announced on Monday that they intend to start purchasing individual corporate bonds which is a big step into the secondary market for the lender of last resort having initially laid out plans to participate in the primary market only. They’re clearly telling investors that they have their back and that they can get long with confidence. Monday’s announcement came after last week’s reiteration of the Fed’s ‘no rate hikes in 2020’ stance and a solid 5% jump forecasted for next year’s GDP.

Even if this year will see an expected contraction of 6.5%, they’re clearly seeing the light at the end of the tunnel. This optimism is being seen in the hard-hit travel industry too, with bookings starting to creep back towards somewhat normal levels and TSA check numbers continue to increase.

An early dip in Monday’s session was quickly reversed, with stocks finishing the day up 3.5% from session lows. The usual suspects in the tech space led the way.

What to Watch For

It looks like the market’s action in the next few weeks will depend heavily on how the current rise in COVID-19 cases in states like Texas and Utah plays out. They were among the states who enforced much lighter restrictions during the initial wave of infections and are now finding themselves at the forefront of a potential second wave. The CDC issued a warning over the weekend of the potential for fresh nationwide restrictions if cases continue to rise. Investors will have no problem remembering how quickly equities were dumped in the face of the initial restrictions so won’t be slow to get out if it looks like they’re returning.

That being said, as we’ve noted in recent articles, there are some great stocks with long-term potential out there and a dip in the near future could offer the perfect buying opportunity for many on Wall Street who missed the first rally.