Market Insider

Second half outlook: Stock market comeback may hit a wall as coronavirus cases spike again

Key Points
  • Stocks could see more turbulence in the second half of 2020, and gains could be capped as the virus continues to keep a hold on the economy.
  • The S&P 500 is still about 5.3% lower year-to-date, even with a near 20% jump in the second quarter, which ends next week.
  • Besides the virus, markets could face volatility from the November election later in the year.
  • A surge in new Covid-19 cases spooked markets Wednesday, amid worries that the recovery may not be as vibrant as stock investors have been expecting.
A view of people passing by New York Stock Exchange in Wall Street amid Coronavirus Pandemic on April 5, 2020.
John Nacion | NurPhoto | Getty Images

Stocks could face turbulence and limited gains in the second half of the year, as the Covid-19 pandemic continues to set the course for markets and the economy.

The S&P 500 had been up more than 20% for the second quarter before Wednesday's 2.6% decline, as a surge in virus cases in Florida, Texas and other sunbelt states raised fears that the economic rebound could be slowed.

The first half of the year saw stocks rise to new highs amid optimism after the phase one China trade deal, but then plummet in March, as the virus shut down the economy. But a heavy and rapid dose of fiscal and Fed stimulus pulled markets out of a downward spiral, and the Nasdaq led the pack, as the first index to set new highs. The S&P 500, at 3,050, is still down 5.6% for the year-to-date.

With just a week left in the second quarter,. the negative news on the virus is a setback and a reminder that the health crisis could continue to dampen economic activity and strain health systems and local government budgets. Some strategists say the market mood is changing, and with the virus spread, the focus may shift to whether and how quickly Congress will approve more economic stimulus.

"People who are looking for a magical V [recovery] are delusional," said Julian Emanuel, head of equities and derivatives strategy at BTIG.  "The delusional part is when you look at the Nasdaq, it made a new all time high.  That's buoying the public's optimism and pulled institutions off the sidelines."

Investors jumped into defensive, stay at home stocks, like Netflix, Facebook, Amazon and consumer staples, when the economy was first shut down. But as they became optimistic about the economy recovering, they moved into the beaten down names, like airlines or casinos, and cyclicals like financials and energy to bet on the rebound. All of those stocks were hit Wednesday, as the Dow fell 710 points, off 2.7%.

Emanuel said the fact that institutions have put more money into stocks recently means they are no longer underinvested  and compelled to buy. "That's different than what we saw in May and the first several weeks in June," when they had to chase performance, he said.

"We are now no longer in a mindset where good news is likely tot be interpreted as good news and bad news is likely to be shrugged off," said  Emanuel. "Bad news will be bad news."

Emanuel expects the S&P to end the year at 3,000, and the market should start setting new highs next year. "The path is going to be extremely volatile. That's what the VIX above 30 is telling you. Our price target is 3,000. We're basically going to have a lot of volatility on either side of tat number, and it's going to be more volatile, not less as we get closer to the election." The VIX, the CBOE's Volatility Index, reflects investing in puts and calls in the S&P 500. A higher VIX indicates more volatility, and it jumped more than 7.8% Wednesday to 33.84.

Besides the uncertainty surrounding the virus, markets also face uncertainty as the presidential election approaches. Currently, the polls show former Vice President Joe Biden in the lead, ahead of President Donald Trump. Some political strategists believe there is a chance that a strong showing by Biden and the Democrats could result in a blue sweep with Democrats in the White House and both chambers of Congress.

Ed Keon, chief investment strategist at QMA, said the market may not react to the November election until after the summer. "Four months is a lifetime in politics," he said. '"If you actually look at the party of the president, it doesn't have very much correlation with the stock market, and if anything it suggests that the market does better under Democrats than Republicans. If Democrats take control, you're going to see some of the tax cuts reversed and that will probably be taken to be negative."

But in the meantime, the prime focus is on the virus and how it is impacting the economy. Besides the news of a jump in cases in the south and California, the governors of New York, New Jersey and Connecticut announced a quarantine for travelers from hot spot states. That slammed airline stocks and raised concerns of a slower economic recovery.

"We were already down and that just took us down another leg," Keon said. "I've been reasonably cautious for awhile. we've had some moves up and down, but we've pretty much been sideways on the S&P for a month plus." 

Liz Ann Sonders, Charles Schwab chief investment strategist, said while there's been a flat trend, the Nasdaq has bucked it in recent weeks.

"Although the Nasdaq hit a new high and has been on a spike, less than 50% of its constituents are trading above the 200-day moving average. That's the biggest divergence since 2001," she said. "There are 45% of the Nasdaq trading above the 200 day moving average in a a rally that's been epic."

The 200-day moving average is a technical measure of momentum. It literally is an average of the last 200 closing prices of a stock or an index, and a move above it is seen as positive momentum.

"It's hard to paint a rosy picture when that's your classic story of the generals advancing and the soldiers falling behind. I think you add the virus stuff to more attention given to these technical divergences and sentiment being stretched and you have a recipe for a pullback," she said.

Sonders said the virus will steer stocks through the end of the year,  and even with reopenings, the virus could still influence consumer and corporate behavior.

"The market in both directions is impacted by the virus," she said. She pointed to the fact that in just four sessions when there was positive drug or vaccine news, the Dow gained 2,700 points in just those sessions.

"What concerns me is the market has gotten pretty frothy," she said, noting it's a positive that the small caps given back some gains.

"Investors ares positioned very optimistically,"  she said, adding some of the sentiment surveys don't reflect the level of optimism apparent in investor behavior. "When you get to extremes of sentiment in either direction it often takes less of a catalyst to ignite the naturally contrarian move in the market. That's what happened in February. I am pleased to see in the last week or two some of the air is coming out of the riskier small cap stocks."