November 29, 2021
The “Nu” variant of the Covid virus is making the rounds in South Africa and has put the fear back into investors that we are once again heading for economic lock/shut down. Friday’s trading is usually very quiet with a few folks coming in to trade a bit and head back home to finish off the Thanksgiving leftovers. However, this year, trading was the worst in 70 years as investors sold anything that benefits from an open economy. Even energy prices fell 10%. The economic data from earlier in the week was solid, with the weekly jobless claims the lowest since 1969 and consumer spending still robust. That all got tossed out the window Friday. The weekend should provide some information that may help investors assess the economic and markets risks heading into December. As usual, technology did better, and bond prices rallied as investors warmed to working at home longer and a Fed that is not likely (now) to be raising rates. If the focus turns more toward the latest variant, then the economic data won’t matter as it will be considered “old news”.
The markets have been trading poorly over the last two weeks, with only one day showing more stocks rising than falling. Friday was the culmination of a bad string, with nine times more declining volume than advancing on the NYSE. The last occurrence was back in September, just before the markets bottomed, resulting in a big October run. At least in the short-term, the selling may have peaked. That doesn’t mean stocks trade higher but expect more ragged trading as we get deeper in the Christmas season. Much of the trading next week will likely center on the path of the new Covid variant. If it is determined to be relatively mild, stocks could regain much of the losses. However, if it poses more risks, then stocks could trade lower still. The employment figures will end the week. The report should be very good and could bolster the markets. Although stocks may be once again beholden to the path of the virus.
As stocks declined, bonds rallied, and interest rates declined. Investors are now expecting the Fed to slow down their pace of tapering their bond purchases and are willing to keep interest rates low. The yield curve has continued to flatten and is now the flattest in eight months. One other concern is the high yield spreads, which are widening. This combination, were it to continue for a few more weeks, could put additional pressure on stocks. For bond investors, treasuries will likely also be a safe port in a storm. The decline in interest rates is likely to continue as commodity prices are showing more signs of rolling over as well. If demand for goods and services wanes in the coming months, prices (and inflation) are likely to moderate.
Friday’s decline was across the board and left few parts of the market unscathed. As mentioned above, the bond market is beginning to signal that stocks could be facing some headwinds in the coming months. Historically, when we see the difference in yields between high yield bonds and treasuries widen out, the stock market runs into trouble down the road. The lead time is anywhere between three months to over a year, so it makes sense to begin watching the markets a bit more closely. The final part of the “market signal” is the flatter yield curve. When the difference between the two- and ten-year yields on treasuries begins to narrow, it is a sign that financial conditions are beginning to tighten. Again, this is not a call for the end of the bull market but is worth keeping an eye on in the coming months. Whenever the markets decide they have had enough, there are likely to be a few hiding places. Better parts of the market will likely be those that have not really participated over the past year, like value and international holdings.
Whether the new variant is at the center of the markets concern or a Fed that may be making a policy mistake, the markets are beginning to pay attention. If things begin getting rougher, treasuries will be a good hiding place.
The opinions expressed in the Investment Newsletter are those of the author and are based upon information that is believed to be accurate and reliable but are opinions and do not constitute a guarantee of present or future financial market conditions.