This is quite a timely post as the US Federal Reserve just cut interest rates to near zero and announced a fresh round of QE. In one of my earlier posts, I discussed about the big credit bubble we are in and it seems like the COVID-19 outbreak might just be the pin that burst the bubble.
We see that the Fed made 2 emergency rate cuts over the past few weeks and the massive injection of $1.5 Trillion (yes, with a "T") to the REPO market. All these indicating the seriousness of the problems in the credit/bonds market. Essentially, there is insufficient liquidity in the REPO market for banks to keep afloat. In a recent video by George Gammon, he also pointed out that there is a lack of good collateral in the REPO market as well for it to function properly.
Interestingly, the US stocks futures market reacted negatively to these sudden actions from the Fed. The stock futures hit limit down again and is poised to open lower when the market starts trading later today. Is it then fair to say that measures taken by the central bankers are useless this time round? I think it might be too early to judge.
For now, I think the stock market had reacted negatively not because of what the Fed did but how they have done it. Instead of waiting for the scheduled FOMC on the 17-18 March, the Fed did the rate cut and QE on a Sunday. This inevitably suggests to the market that the problem is so huge and require immediate actions.
I think in weeks to come, we will be able to see the effects of the money stablizing the credit market and boosting confidence. Once that happens, we should be able to see some revival in the stock market and even a strong relief rally.
Are stock markets cheap now?
Based on the Buffett Indicator, which takes the total stock market cap divided by the GDP, it is still significantly overvalued despite the recent crash.
And if we look at the Shiller P/E, it is also significantly higher than historical mean. The idea of Shiller P/E is that it tends to reverse to mean over a period of 8 years. And given this understanding, the stock market is projected to only make 0.2% annual returns over the next 8 years.
It is also important to note that the COVID-19 outbreak has also resulted in a slowdown in business activities and productivity. On top of this, we see potential supply chain disruptions that further impact companies' earnings. All these are likely going to lead to a recession. This means that the Buffett indicator should be even higher since the projected GDP is lower if there is a recession. Shiller P/E should be even more overvalued since the projected earnings by the companies are going to get weaker.
Where do I stand?
As in my previous technical analysis, I believe that the market is oversold in the short-term. I think there will be a bounce in the upcoming weeks. However, fundamentally there are serious problems in the credit market and the stock market is still highly overvalued.
Hence, in the very short-term (weeks to a month), I expect a bounce. However, in the longer term (beyond a month) I see the stock market breaking down as recession sets in and companies start to project future results in the upcoming earnings season.
Again, this is my own analysis and you should always do your own due diligence and research.
In my next article, I am going to give my take about how all these craziness is going to affect gold and cryptocurrencies. Stay tuned...
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