Some theories on why the stock market rebounded so much and whether it will fall back to the lows

Published Wed, Apr 22 20206:58 AM EDT

Stocks posted a swift rally ever since hitting a low on March 23 that has left some investors baffled. The S & P 500 has surged nearly 25% since late March. That rally retraced about half of the market's decline from a Feb. 19 record. The broader market average's gains come even after a 4.8% drop this week amid a sharp fall in oil prices. The Dow Jones Industrial Average and Nasdaq Composite are also up sharply since reaching their late-March lows. While the rally was welcomed by many, it also left investors wondering why the market rebounded so much so quickly. It also raised questions about the rally's sustainability. Some of the theories raised by Wall Street experts include fiscal and monetary policy responses to the downturn and a declining number in new coronavirus cases. Another theory about the rally is investors may not have had a choice but to buy stocks. Massive stimulus The Federal Reserve took up a series of unprecedented monetary stimulus measures, including an open-ended asset purchase program. Some of the assets the Fed is buying under this program include corporate bonds, including junk-rated paper, through exchange-traded funds. On the fiscal side, U.S. lawmakers and the Trump administration approved a $2.2 trillion stimulus package that includes direct payments to Americans and loans for small businesses. "It is certainly the case that governments have acted very rapidly and in enormous scale," said Inigo Fraser-Jenkins, co-head of portfolio strategy team at AB Bernstein, in a note to clients. "Jumping straight to salary support and helicopter money certainly seem like the right kind of policy reactions to the current crisis." "The other aspect is the monetary response, especially in the US," Fraser-Jenkins said. "There is the old adage of 'don't fight the Fed' … That logic would imply that investors should just buy exposure to the credit assets that the Fed is buying and equities that would benefit from portfolio rebalancing into riskier assets." Those actions contributed to a massive multiple expansion. The S & P 500's forward price-to-earnings ratio — a valuation metric widely used by investors — has shot back to 19 after tumbling to 13.26 on March 23, FactSet data shows. But that expansion also comes amid dwindling earnings estimates as analysts slash their forecasts to account for the hit businesses are taking amid the coronavirus outbreak. So far, 14% of S & P 500 companies have reported earnings, according to data from The Earnings Scout. Of those companies, 65% have exceeded earnings expectations. However, first-quarter S & P 500 earnings were still on pace to fall 13.8% on a year-over-year basis through Tuesday morning. "The market rally since the March lows has been completely driven by a recovery in the multiple as earnings expectations continue to collapse," Keith Parker, a strategist at UBS, wrote in a note to clients. "With multiples back at the highs for the S & P 500, the direction of the market then seemingly comes down to how sustainable are multiples and where earnings may settle." Declining coronavirus infection rate Another theory is the market got a boost as the number of new coronavirus cases appears to have peaked. Data compiled by Johns Hopkins University shows new coronavirus cases hit a high of more than 99,000 on April 12. Since then, the number of new cases hasn't topped 97,000. In the U.S., new cases hit a high of 33,800 on April 10 and have plateaued since then. In New York — the U.S. state with the most confirmed cases — coronavirus-related hospitalizations have fallen in recent weeks, according to Gov. Andrew Cuomo. New Jersey Gov. Phil Murphy said Sunday the state is "flattening the curve" of new infections. "Coronavirus developments have been a primary driver of equities the past three months. We find that the log level and log change in new cases globally can explain moves in the S & P 500," said UBS' Parker. This has also led to discussion of re-opening the global economy. In the U.S., President Donald Trump has been pushing for a restart by early May in some states. The German government has also started to slowly reopen the economy. 'TINA'? At the same time, investors might not have had a choice other than to buy stocks after the sharp decline from record highs. Equity prices depreciated at a historically fast pace from Feb. 19 to March 23, but other asset classes weren't that much more attractive. Treasury yields, for example, fell to historically low levels, taking the luster away from U.S. sovereign debt. The 10-year U.S. Treasury yield briefly traded at 0.31% in March, an all-time low. The rate has recovered somewhat since then but remains below 1%. "It is possible that markets are rising in response to the view that investors have little other realistic alternative in terms of allocation if they want to find assets that can deliver a positive real return in the environment in which we find ourselves," wrote Bernstein's Fraser-Jenkins, referring to "TINA," an acronym that means "there is no alternative." To be sure, there are still concerns over whether this rally can last given the potential deterioration in corporate earnings along with the potential of a second wave of new cases. Crude prices have also been in free-fall this week, pressuring the major averages and mounting concerns over potential job losses in the energy industry amid a lack of demand for oil. The May contract for West Texas Intermediate fell into a negative price on Monday. On Tuesday, the June contract for WTI dropped over 43%. Through Tuesday's close, the Dow was down more than 5% while the S & P 500 and Nasdaq had lost over 4%. Still, the averages remained well above from their late-March lows. "The equity market's rapid, sharp moves have made investing somewhat treacherous as every headline seems to cause a potentially volatile response," said Tobias Levkovich, chief U.S. equity strategist at Citi, in a note. "Major policy shifts by the Fed or Congress arguably deserve such reactions [higher] if tail risks are removed, but ultimately it should come down to deeper analysis, earnings and Street confidence." —CNBC's Michael Bloom contributed to this report. Subscribe to CNBC PRO for exclusive insights and analysis, and live business day programming from around the world.

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Stocks posted a swift rally ever since hitting a low on March 23 that has left some investors baffled.