A look at what's driving the equities rally
2021 has been a turbulent year for the world and for the markets and financial traders. Hopes last year that the COVID pandemic would be consigned to history by now, were dashed amidst the outbreak of a second wave of the virus over the start of 2021. Since then, many countries have seen a third wave and even a fourth wave of the virus. The ongoing uncertainty around the virus has prompted a variety of market moves. One of the standout moves of the year has of course been the rally in equities markets, with indices around having seen huge moves higher. With many stock markets, particularly in the US, sitting at or near record highs, the big question now is whether stocks can keep rising?
What Has Driven the Rally?
Firstly, let's unpack why stocks have been on such solid journey higher this year. It's important to remember that in response to the unfolding of the pandemic last year and the economic crisis which ensued, central banks around the world were forced to take record action. In many cases this involved unprecedented moves. For example, in the US the Fed unleashed an unlimited QE program (meaning there was no monthly quota, it would simply buy as much as necessary). The Fed also announced for the first time ever that its monthly QE purchases would not just cover bank debt but would also include corporate debt. Elsewhere, hosts of central banks were forced to slash rates and ramp up asset purchases.
Most Central Bank Easing Still in Place
The impact of this huge wave of liquidity is still being felt right now. Many of the central banks which were forced into action are continuing with monthly asset purchases currently, which is still feeding into higher equities prices. With companies underpinned by easier financial conditions, borrowing and spending continues to grow, which feeds into higher prices in stock markets.
Looking at the current COVID backdrop, however, many traders ask why markets are still rallying if fears are resurfacing. The answer to this once again lies in central bank monetary policy. With the second wave fading over Q2 and vaccination rates and reopening optimism growing, many traders began anticipating that we would see central banks scaling out of these easing programs over the summer.
Fears Over New Variants
However, fresh fears over new COVID variants and fears that further variants will develop that will make the vaccines ineffective, traders are now dialling back their tightening expectations. While we have seen some hawkish movement with central banks such as the BOC and RBNZ scaling back QE, the more important central banks such as the Fed, the BOE and ECB, remain committed to easing in the wake of these residual risks. That means for equities traders, the risks of these central banks tightening monetary policy in the near term are subsiding, paving the way for equities markets to go higher.
Looking ahead then, the path for equities markets hinges quite clearly on the path of the pandemic. If fears continue to grow around fresh COVID variants, this will further reduce the risks of these central banks beginning to tighten monetary policy. Specifically, in the west, the big fear is that as summer passes as the seasons change through autumn and winter, the pandemic will see a fresh surge.
Lockdowns, Tightening and Other Factors
Again, in this scenario equities are likely to stay supported, while central banks are kept from tightening. Should the spread of the virus become too severe however, and fresh lockdowns are needed, this could be a big downside driver for equities, around the same scale as central bank tightening. So, while equities can certainly continue higher, it would appear that corrective risks are growing. These risks for equities stem from virus fears passing and central banks commencing tapering or, the virus resurfacing to the point where fresh lockdowns are needed. So, when thought of like this, the conditions in which equities can continue rising, appear quite limited.
The current price action shows the S&P sitting withing a contracting triangle pattern, within the lower half of the long-term bullish channel. Following the breakout above prior 4383.50 highs, momentum has since stalled with both the RSI and MAD indicators flattening. However, while the level holds as support, focus in on a break higher, with the current formation viewed as consolidation within a bullish trend. To the downside, a break below the current structure would turn focus to support at the 4295.75 level next, with the rising channel low coming in just above.
This article was submitted by Tickmill.
Disclaimer: The material provided is for information purposes only and should not be considered as investment advice. The views, information, or opinions expressed in the text belong solely to the author, and not to the author's employer, organization, committee or other group or individual or company.
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