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After one of the worst quarters on record, stocks are rising again amid hopeful signs the spread of COVID-19 is slowing in some of America's hardest hit communities. But, say Wall Street strategists, everything will need to go right for the rally to last.

On Monday the Dow Jones Industrial Average soared more than 7% after reports that the rate of coronavirus infections was slowing in New York, the epicenter of the U.S. pandemic. While the market ended largely flat on Tuesday, on Wednesday morning the Dow rose again, gaining about 160 points, or 0.7%, in early trading.

Conditions have turned more favorable for stocks because of the massive economic stimulus bill recently passed by Congress and the Federal Reserve’s willingness to use its so-called monetary 'bazooka', that includes lowering short-term interest rates to zero and buying trillions worth of longer-dated bonds among other things, in order to reassure skittish fixed-income markets.

“It turns out the Fed’s response and the historic $2 trillion stimulus package has really provided a short term safety net,” said Edward Moya, senior market analyst at foreign-exchange brokerage OANDA.

But Moya and others warn that, even if the worst of the pandemic is behind the U.S., the worst of the economic pain is yet to come. While the U.S. stock market is technically on the cusp of a new bull market — meaning up 20% from it's bottom — there’s still a chance that the rally is a “head fake” and the lows of mid-March could be revisited.

How the new bull market could last

The “virus makes the timeline,” said Anthony Fauci, head of the National Institute for Allergy and Infectious Diseases, in a March interview with CNN”s Chris Cuomo. He was talking about the timeline for social-distancing lockdowns, but he might also have been talking about the timeline of the stock-market recovery.

If there are further signs that the rate of infection has plateaued in New York and in the nation as a whole, then strategists see a good chance that the rally will continue, at least in the short term. “That has really provided the light at the end of the coronavirus pandemic tunnel,” says Moya. “If we have turned a corner, you’re not going to be too far away from more of a focus on the reopening of economy.”

Another reason to be hopeful is that some of the signs of financial stress that worried Wall Street veterans in mid-March have eased, thanks to the Fed’s intervention. The dollar has given back a large chunk of its gains against other currencies, a sign that investors are more comfortable with credit risk. The volatility in Treasury yields has diminished, making it easier for banks to set rates for loans. The CBOE volatility index, or VIX, has fallen considerably, reflecting lower premiums paid for portfolio insurance.

“The Fed has thrown essentially the entire 2008 playbook at markets, but done so in the space of three weeks as opposed to three months,” says Scott Clemons, chief investment strategist at private bank Brown Brothers Harriman.

But the course of the coronavirus – and the associated stock-market recovery – is unlikely to be smooth.

“This will come in waves,” as the epicenter moves from New York to other areas, says Oliver Pursche, chief market strategist at broker-dealer Bruderman Brothers.

How the bear could come back

Stocks are rising on a “best-case scenario” thesis. In this scenario, the spread of the coronavirus has peaked in the U.S.; towns and cities reopen for business; and pent-up demand leads to a rapid recovery of the economic production lost during the shutdown.

But will economic activity return at the flick a switch? Can small businesses survive this shock even when their customers come trickling back?

Moya, of OANDA, says the upcoming government support for small businesses and the services industry could turn out to be more of a “band aid” than a rescue if, as he suspects, the return to “normal” economic behavior in the U.S. is slow. A wave of retail and restaurant bankruptcies, or a major bankruptcy on the oil patch, could be enough to trigger another plunge in the stock market. “You have too many new 'black swan-type' events that will emerge from this and I think that you’re really kind of hoping for a lot of things to go right for the rally to continue,” says Moya.

History does not bode well, either.

Some “time travel” back to October 2008 is instructive, said Carol Zhang, a strategist at brokerage Bank of America Global Research, in a recent note to clients.

That's when the failure of Lehman Brothers Holdings toppled series of financial dominoes, triggering the largest market crash in a generation. It was an event almost as sudden and catastrophic as the sudden onset of the coronavirus.

Then came a lull. While markets never saw quite the sustained rally that we’ve seen in recent weeks, there were some sustained gains at the turn of 2009 as the Federal Reserve’s interventions in credit markets – similar to those that we’ve seen in recent weeks – paid off. Investors believed everything was “priced in,” that they were prepared to see all the red ink on upcoming earnings and economic reports.

But it’s one thing to hear a prognostication, like former Federal Reserve Chairman Ben Bernanke’s recent estimate that second-quarter gross domestic product growth could fall 38%, and another to see those statistics hit the tape.

When the final cathartic plunge came in March 2009, nearly five months after the initial shock, nobody was talking about “buying opportunities” or “v-shaped recoveries.” The once-hopeful bulls had capitulated, and the conventional wisdom was that stocks were a mug’s game.

The Bank of America strategists see the current move as a “tactical rally,” a display of short-term, instinctive relief at slowing growth in coronavirus cases, which could later give way to new bear-market lows. “Trade the case count now and economic costs later,” wrote the strategists. “We think sobering reality after COVID-19 peak will hit the market again.”

For what it’s worth, Moya, who is working from home in New York, says he’s heard more ambulance sirens than ever in the last couple of days.

We’re not out of the woods yet.

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