S&P 500 U-Turns to Reach Record Highs on China Liquidity Injections

After dropping to close at its lowest point of 2020 the week before on fears of the disruptive economic impact of China’s coronavirus outbreak, the S&P 500 (Index: SPX) performed a U-turn in the first week of February 2020, setting two new all-time record highs for the index during the week before dipping slightly on Friday to close the week 102.19 points (3.2%) higher than it had in the previous week.

If you’re a regular reader of our S&P 500 chaos series, you already know the reason why. If you’ve just joined us, here’s the key bit of analysis from the article we posted early on Monday, 3 February 2020, well before the markets opened:

At this point, it is a little too early to identify the downward fall in stock prices as a new Lévy flight event, which would be the second such event in 2020, though last week’s action on Friday, 31 January 2020 suggests it may be the start of a new one. If it is, where we would see investors fully shift their focus toward 2020-Q2 in setting stock prices, the S&P 500 would have the potential to fall somewhere on the order of 300 points if nothing prompts them to refocus part or all of their attention on 2020-Q4.

We’ll find out soon enough, where China’s stock market will be reopening this week, although with restrictions against short selling and also with China’s government likely to inject new liquidity into the nation’s stock markets to boost them, which may affect other stock markets around the world depending on how much liquidity they add.

That last paragraph is something of an understatement, because China’s central bank injected an absolutely massive amount of liquidity into its markets in the last week.

Typically, China’s central bank (PBOC) floods the system with liquidity ahead of the lunar new year holiday to ensure banks can fund themselves for the week off and window-dress/support asset-values to ensure optimism and consumption continue. Also, typically, that repo-provided liquidity is rolled off shortly after the holiday is over…

However, this year, as the lunar new year liquidity provision began, the ominous signs of a deadly virus were building and PBOC decided that instead of unwinding the large liquidity provision, they would double-down on it… and that they did in size.

The last four weeks have seen China supply over CNY2 trillion (net!) into its financial system – something we have never seen anything like before…

And that unprecedented wave of $300 billion liquidity injection lifted every boat in every storm…

But it wasn’t just China injecting liquidity into its markets. The Federal Reserve also cranked up its liquidity support operations in U.S. money markets during the last week.

Together, the central bank actions have reduced volatility, boosting stock prices. Here’s what that looked like for the S&P 500 on our spaghetti forecast chart:

Last week, we confirmed that the decline in stock prices on Friday, 31 January 2020 occurred as investors were shifting their forward-looking attention toward 2020-Q2 as the likely timing of the Fed’s next interest rate adjustment, as the dividend futures-based model we use in our analysis anticipates would happen in that case. This past week however, stock prices rose, which suggests that investors shifted their focus away from 2020-Q2, toward a more distant future quarter. The latest snapshot of the Fed rate change probabilities recorded by the CME Group’s FedWatch tool suggests that might be 2020-Q3:

This is where we have to add a note of caution, because we’re dealing with a rapidly evolving situation in the markets. If you look at the alternative futures chart above, if investors shift their attention fully toward 2020-Q3 in setting current day stock prices, the S&P 500 could continue to rise by as much as 250-300 points. But, if China’s and the Fed’s liquidity injections work to stabilize markets as intended, the FedWatch tool’s probability estimates may only have caught investors in the process of shifting their focus more fully back toward 2020-Q4, which is consistent with the S&P 500′s recent trajectory, which would also mean that stock prices are within a few percent of where they might go.

We’ll find out which scenario applies, or if something happens to refocus investors on 2020-Q2 to send stock prices lower, during this next week. Until then, here are the market-moving headlines we found in the flow of the past week’s news streams.

Monday, 3 February 2020

• Oil hits 13-month lows as coronavirus cuts demand
• Economic contagion from China’s coronavirus crisis:

• ECB’s De Guindos says coronavirus outbreak creates uncertainty
• China’s coronavirus bound to hurt Germany’s struggling manufacturers: IHS Markit
• China commodities nosedive as coronavirus raise consumption fears
• Hong Kong recession deepens, fourth-quarter GDP shrinks 0.4% quarter-on-quarter

U.S. manufacturing rebounds; Boeing, coronavirus loom

Wall Street rebounds from virus fears, helped by factory strength and tech stocks

Tuesday, 4 February 2020

• Oil falls 1% as demand fears outweigh hopes for bigger OPEC+ cuts

• Oil flips into contango, indicating months of supply

Bigger trouble developing in China, spreads beyond borders:

• Automakers close factories in China due to virus outbreak
• Hyundai to halt South Korea output as China virus disrupts parts supply
• Coronavirus to slow down demand growth, says ConocoPhilips
• New Zealand loggers, U.S.food exporters suffer from China’s virus clampdown

Bigger stimulus developing in China:

• China central bank says huge cash injections to stabilize market expectations, restore confidence
• Exclusive: As virus fallout widens, China readies more measures to stabilize economy – sources

Fed floods U.S. money markets with liquidity:

• Liquidity Panic Returns: Term-Repo Most Oversubscribed Since Start Of Repo Crisis As Fed Injects $94.5BN
• Fed’s Bostic says new virus hasn’t changed his outlook

Wall Street jumps as China stimulus measures soothe virus worries

Wednesday, 5 February 2020

• Stimulus hope, virus containment steps fuel renewed equity surge

• Oil prices jump 2% as virus reports spur hope

• Factbox: Coronavirus hits demand for oil, energy

Stocks jump on media reports of drug breakthroughs for coronavirus: traders

Economic impact of China’s coronavirus epidemic:

• China January exports, imports seen falling, virus risks global trade disruptions: Reuters poll
• China’s services sector growth hits three-month low in January: Caixin PMI
• Wilted flowers, empty cafes: China’s small businesses bear coronavirus costs

Bigger trouble, stimulus developing in China Indonesia:

• Indonesia’s fourth-quarter GDP growth weakest in three years, more rate cuts seen
• Indonesia government seeks parliament approval for corporate tax cuts, other tax changes

Fed’s Daly: I don’t think coronavirus will have material impact on U.S. economy

S&P 500, Nasdaq mint record highs after strong U.S. data, waning virus fears

Thursday, 6 February 2020

• Oil prices flat; OPEC+ mulls supply cut as virus hits demand
• China’s coronavirus epidemic affecting global trade:

• China’s coronavirus disrupts global container shipping trade
• Coronavirus may knock 0.1-0.3 percent point off Indonesia’s 2020 GDP growth: minister
• Australia economy to take ‘significant’ hit from coronavirus: Morrison
• China likely considering disaster clause in Phase 1 deal with U.S.: Global Times
• China expected to maintain trade commitments despite virus outbreak: Mnuchin

• China to halve tariffs on some U.S. imports as coronavirus risks grow

Euro zone bank bailouts in works:

• ECB’s De Guindos says cross-border mergers would help move towards European banking union
• Europe needs to rebalance bank buffer rules: de Guindos

Fed minions comment on economy, policies:

• Fed’s Kaplan says he expects solid U.S. growth this year

• Fed’s Kaplan says base case is for no change to rates this year

Quarles says Fed could better align Treasuries, reserves to ease repo pressure

• Fed’s Quarles says 2019 money market friction suggested need for more reserves

Wall St. reaches new highs as China moves to limit coronavirus impact

Friday, 7 February 2020

• Oil falls 1% as Russia needs time to mull more OPEC+ supply cuts
• Bigger trouble, stimulus developing in China:

• Coronavirus could shrink China auto market by 3%-5% in 2020: LMC Automotive
• China says will not release trade data for January, will combine with February
• China’s central bank vows to step up support for virus-hit economy
• China’s January yuan loans set to jump to 3 trillion yuan, virus darkens growth outlook: Reuters poll

Fed says risks to economy easing, but calls out coronavirus in report to Congress

Indexes drop from record highs, but tally strong weekly gains

Elsewhere, the Big Picture’s Barry Ritholtz counted up the positives and negatives he found in the past week’s economics and market-related news and we have to say that he nailed the #1 items in both the positives and negatives this week.