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Why the stock market continues to rally as coronavirus shuts down the economy and sends high unemployment

Main Street thinks Wall Street is crazy. Wall Street believes that Main Street will be relatively OK.

It is the obvious message after the Dow Jones industrial average
+ 1.90%

jumped more than 400 points Friday and stocks continued a difficult rebound despite data showing that the US economy threw more than 20 million jobs in April. Locks aimed at containing the deadly COVID-1

9 pandemic pushed unemployment up to 14.7% – a high post-war period that economists say is likely to understand the devastation.

Read: Major Depression 2020? The unofficial US unemployment rate is at least 20% – or worse

Advisers and analysts say they have become redundant with calls from customers asking why stocks continue to rise as financial data gets uglier for the day.

They have a well-worn list of reasons: the market is forward-looking and has already expected a sharp but short recession; there are tentative signs that the outbreak has peaked; progress toward treatments and even, potentially, a vaccine; The Federal Reserve releases an unprecedented monetary stimulus and backstops lending, with the promise of doing more; and a number of federal expenditures aimed at acquiring workers and companies, albeit when drawing mixed reviews.

But the test will be whether the consumer – long the main engine of the US economy – grows back to life after being virtually, or even literally, closed during the pandemic.

“Everything will come to consumer spending. If we all sit in and do not spend money in September-October, the market will not like it – the market will go down, “Scott Wren, senior global market strategist at the Wells Fargo Investment Institute, said in a telephone interview.

Whether consumers are outside and closing in will of course depend on how the pandemic plays out. While infections and death rates in New York, the middle of the outbreak in the United States and other urban hotspots have become lower, the outbreaks have worsened in other parts of the country. In the meantime, several states have begun to loosen the restrictions or plan to do so.

Several states have even seen protests against lockdown measures, claiming that the damage to the economy outweighs the potential damage from the virus. Public health experts have argued that the reopening process must be carried out with caution to prevent a second infection wave.

And some economists and investors have argued that efforts to contain the virus, even if it is financially painful in the short term, will prevent the much deeper economic hit that would occur if the spread were to be reversed.

In fact, Bryce Doty, senior portfolio manager at SIT Fixed Income Advisors, claimed that the stock market was boosted by Friday’s dismal job count just because investors see employment in the near future as a sign of the country’s decision to contain the pandemic.

“Lockdowns provided the needed protection and have dramatically slowed the spread of the virus in even the most dense areas of the country, so that populations will actually increase in response to an almost 15% unemployment rate,” he said in emails. “The job report marks a sobering moment in our history [it] probably also marks the bottom of the economic contraction, hoping for a better balance of the year. “

Some market watchers see a bumpy road, claiming that the rally is priced in a best case that could easily be traced by a renewed increase in infections or signs that the economic recovery will not be so rapid. It may put pressure on decision-makers to take further steps in the face of rising partisan tensions in Washington.

“Today, the challenge for the Fed and Congress is to go before this crisis as it develops. After a strong start, there is a great risk that they will fall behind and the sudden hard stop of the economy will turn into a long-term decline that would be devastating, ”said James McCann, senior global economist at Aberdeen Standard Investments, in an email.

S&P 500
+ 1.68%

fell almost 34% from a February 19 record near its March 23 low. The subsequent recovery left the high-capital index just 13.5% closed throughout the day on Friday.

At the same time, a look under the market hood tells a story, with revenue and results from the first quarter showing that investors continue to make a distinction between “haves” and “have-nots.” In other words, investors favor shares in companies that are prepared to bet the pandemic and lockdowns, while still being cautious about shares in companies that are more sensitive to the business cycle.

Technology-oriented and non-cyclical sectors are on track to increase earnings by an average of 3.2% in the first quarter, Larry Adam, chief investment officer at Raymond James, noted in a Friday note. However, cyclical sectors, which are closely following the ups and downs of the economy, will see an average decline of 34.7% in the first quarter and 81.6% in the second quarter.

It has been accompanied by technology and healthcare industries that are breaking out to relatively new heights compared to the S&P 500, while economics and industry are lacking, he noted.

Read: S&P 500 revenue beats estimates with the lowest interest rate in a decade in the midst of COVID-19 despite previous cuts in forecasts

Dow recorded a 2.6% gain in the last week to end Friday of 24,331.32, while the S&P 500 advanced 3.5% to 2929.80. The technical heavy Nasdaq Composite
+ 1.57%

has surpassed other major indices and erased its 2020 loss (up 1.7% year to date from Friday) during the past week when it rose 6%.

So from where? No one, of course, really knows, and the extent of the bounce from the March 23 low has surprised even some bulls.

But history shows that a significant recall in the short term would not be a surprise, given the market’s tendency to deliver a 10% decline every 11 months or so, Wren noted. At the same time, it may take some new positive developments on the consumer front to drive the S&P 500 through resistance to its 200-day moving average, which stands at 3,001.98 after Friday’s close, he said.

At the same time, the week ahead will provide additional financial data, including a look at retail sales in April on Friday. Undoubtedly, these figures are expected to be particularly ugly, with economists on average demanding a 8.7% reduction in headline and a 4.5% decline in sales excluding cars.

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