Stocks rose substantially Wednesday as Wall Street is pleased with the effectiveness of monetary and fiscal stimulus so far.
All three major U.S. indices rose, with the S&P 500 up 1.48% to end the day. The 10-Year Treasury yield fell slightly to 0.69%, but it’s still up from 0.64% since May 13, the start of the recent risk-on rally. Yields rise when prices fall.
Monetary and fiscal stimulus appears to be working. In the past few days, it has become clear the money supply has been expanding at a rate never seen before, enabling banks to lend aggressively as rates remain low.
Meanwhile, investment grade credit spreads are tightening, meaning that the interest rate on those bonds is falling to a thin spread over safe treasuries. That comes as the Federal Reserve buys corporate bonds to keep rates low enough for businesses to borrow and remain liquid. High yield spreads are tightening too, but slower, as investors are still demanding some credit risk premium above historical norms. The risks they’re accounting for: a second wave of coronavirus infections and additional U.S.-China tariffs in both directions.
But the move Wednesday was largely risk-on. Value stocks, many of which are cyclical and small caps, both of which see substantial upside when economic expectations see strength ahead and are out of favor with investors in the opposite scenario, outperformed.
The Russell 2000, a small cap index, rose 3.11%. The Vanguard S&P 500 Value ETF (VOOV) - Get Report rose 2.31%. The Invesco KBW Bank ETF (KBWB) - Get Report rose 6.64%. The S&P 500 Equal-Weight Consumer Discretionary Index rose 3.97%.
The market did overlook two minor headwinds.
Russia reportedly said it would be for easing oil production cuts. Crude oil fell 4.3% to $32 a barrel. Oil stocks underperformed. Small, indebted oil companies saw weak days. Occidental (OXY) - Get Report rose just 0.14%.
Also a negative, the U.S. deemed Hong Kong no longer autonomous from China after protests broke out after a national security law passed in China. This underscores rising tensions between the two nations, indicating the threat of more tariffs in both directions.
Here’s what Wall Street’s saying:
Barry Bannister, Head, Institutional Equity Strategy, Stifel:
"We now raise our S&P 500 price target to 3,250 by Aug-30, 2020 (in 3 months), supported by economic survey data improving/bottoming (consumer, services, industrial) and our expectation that the S&P 500 price-to-earnings [ratio] expands (at prevailing low real bond yields) to offset weak earnings per share, typical of late-stage recession periods. Our unchanged view of a positive U.S. GDP inflection in 3Q20 favors reflation candidates (beneficiaries of a weaker dollar, steeper yield curve), which are Financials, Energy, Materials and Industrials."
Brian Levitt, Global Markets Strategist, Invesco:
"Our base-case macro outlook calls for lockdowns to persist for at least a quarter, coinciding with a severe contraction in economic activity. Ultimately, we believe that expanded testing will enable select segments of the economy to reopen, with a broad recovery to emerge with fits and starts. China appears to have successfully managed the initial outbreak and is reopening large segments of the economy, with large percentages of the industrial labor force returning to work. We’ll also take a look at China’s experience in 2003 with Severe Acute Respiratory Syndrome, which may prove an apt way to think about how economic activity may play out in the coming weeks and quarters. The federal government has provided multiple phases of fiscal stimulus, including direct support to small business, households, state and local governments, and hospitals, Meanwhile, the Federal Reserve appears to be “all in” as a lender of last resort to the financial system and providing liquidity support to the financial markets.”
Ryan Detrick, Senior Market Strategist, LPL Financial:
"The Federal Reserve (Fed) increased its bond exchange-traded funds (ETF) purchases in the week ending May 20 (the most recent data available), adding another $1.5 billion in bond ETFs to its balance sheet, bringing the total holding to $1.8 billion. With Fed purchases accelerating, the average investment-grade corporate bond spread dipped below 2% last week for the first time since March 11. At the same time, investors’ greater caution with high-yield bonds makes sense, since they are more vulnerable if the economy doesn’t rebound as quickly as expected.”