Stocks plunge on fears of new Covid-19 variant

The most common cause of low prices is pessimism – sometimes pervasive, sometimes specific to a company or industry. We want to do business in such an environment, not because we like pessimism but because we like the prices it produces. It’s optimism that is the enemy of the rational buyer. – Warren Buffett

The major stock averages were headed for modest losses last week until news broke on Friday that officials at the World Health Organization (WHO) warned of a new Covid-19 variant called Omicron that was found in South Africa. The troubling news sent stocks tumbling as the Dow Jones Industrial Average posted its worst day of the year with a loss of 2.5% and the stock market saw its worst Black Friday on record. The Russell 2000 Index of small cap stocks was down over 4% for the week while the technology-heavy Nasdaq Composite Index dropped 3.5%. Scientists in South Africa detected 30 mutations to the spike protein, which is the part of the virus that binds to cells in the body. Worries spread that the number of mutations could reduce the effectiveness of vaccines in combating the virus. The price of oil plunged over 10% and fell below $70 a barrel as concerns rose that the new Covid variant would affect global demand. Investors decided to shoot first and ask questions later, dumping their equity holdings in favor of bonds as the yield on the 10-year Treasury declined to 1.48%. (Bond prices and yields move in opposite directions). This risk-off behavior by investors might have been exacerbated by the fact that Friday was a shortened session with many market participants out of the office. This contributed to the very low trading volume and increased volatility as there were fewer traders able to take the other side of the trade. Until more is known about the symptoms associated with this variant and its possible economic impact, there is no reason to overreact and panic. Prior to this news on Friday, the other important event last week was the release of the minutes from the November Federal Reserve meeting. They showed that Fed officials were ready to accelerate the timetable for reducing asset purchases and raising the federal funds rate if inflation remains stubbornly high. While the monthly bond buying program will still likely end by early summer of 2022, markets are anticipating a more aggressive Federal Reserve and the distinct possibility of higher interest rates sooner than expected.

Last Week

The October core personal consumption expenditures (PCE) index, the Federal Reserve’s preferred measure of inflation and the one that excludes volatile food and energy prices, increased 4.1% from a year ago, in line with estimates. Durable goods orders in October fell more than expected but excluding transportation, they actually increased modestly while second quarter gross domestic product (GDP) was revised up slightly to 2.1%. Weekly jobless claims fell to 199,000, much lower than estimates and well below last week’s total of 270,000. Existing home sales were fairly strong in October but lower than in October 2020, which was the cyclical high for the market. Finally, the University of Michigan consumer sentiment index for November dropped to its lowest level in a decade due to rising inflation.

Jerome Powell was chosen again for a second four-year term as chairman of the Federal Reserve as continuity was cited as an important factor with the economy recovering from the pandemic.

For the week, the Dow Jones Industrial Average dropped 2.0% to close at 34,899 while the S&P 500 Index declined 2.2% to close at 4,592. The Nasdaq Composite Index lost 3.5% to close at 15,491.

This Week

The employment report for November is expected to show that 525,000 new jobs were created and that the unemployment rate edged lower to 4.5% from 4.6%. The ISM Chicago Purchasing Manager’s Index (PMI) for November is forecast to be only slightly below its peak back in May while the ISM manufacturing and services sector indices are also forecast to be strong with readings well above 50, the threshold for expansion. The consumer confidence index in November is expected to be lower than in October and well below its highest level during the summer due partly to inflation concerns.

Among the most prominent companies scheduled to report quarterly earnings this week are Hewlett Packard Enterprise, NetApp, Salesforce.com, CrowdStrike Holdings, Royal Bank of Canada, Toronto-Dominion Bank, Bank of Montreal, Dollar General, Kroger and Ulta Beauty.

Portfolio Strategy

Although economic data this week should be positive and show the economy is getting stronger, the main focus will be on the Omicron variant of the Covid virus, which spooked the markets on Friday. It is too early to tell how serious this variant will be but initial indications are that while it seems to be easily transmissible, the symptoms are relatively mild. Investors will also be interested in comments from Federal Reserve Chairman Jerome Powell and Treasury Secretary Janet Yellen as both of them are scheduled to appear before Congress. With the Delta variant apparently under control and heightened concern over increased inflation, the Fed has already begun to reduce its monthly bond purchases with the program expected to end by mid-year 2022. If the new variant spreads and disrupts already damaged supply chains even more, inflation could rise further and economic growth could slow. The Fed might have to accelerate its timetable for tapering its bond-buying program, which has the potential of raising interest rates sooner than expected. The price of oil also bears watching after last week’s plunge as OPEC meets this week and could decide to slow its production after the U.S. and other governments agreed to tap their strategic petroleum reserves in order to lower prices. With the possibility of new lockdown restrictions due to the Omicron variant that could slow the global economy, there could be too much oil hitting the markets. All of this uncertainty with regard to the new variant will likely keep the markets on edge over the near-term until scientists are able to learn more about it.