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Stocks fall as concerns mount over impact of Delta variant

The first rule of investment is ‘buy low and sell high’, but people fear to buy low because of the fear of the stock dropping even lower. Then you may ask: ‘When is the time to buy low?’ The answer is: When there is maximum pessimism. – Sir John Templeton

Trees do not grow to the sky and the stock market was evidence of that last week as all three major stock averages took a breather and posted losses. By the end of the week, the S&P 500 Index and the Dow Jones Industrial Average had fallen for five consecutive days but the total losses were confined to less than 2.5% during that time frame. The week after Labor Day is historically a difficult one for the stock market and last week was no exception as the Delta variant’s impact on the economy reopening is causing concern. Goldman Sachs lowered its annual growth forecast for 2021 and cut its fourth quarter outlook due to the surge in positive cases and fading fiscal stimulus. The Federal Reserve’s Beige Book, a survey of economic conditions in the Fed’s twelve districts, also noted that economic growth had slowed to a moderate pace due to the spread of the Delta variant during July and August, particularly affecting the restaurant, travel and tourism industries. There was also concern about rising inflation facing businesses that is being exacerbated by a shortage of goods and will likely be passed onto consumers in many areas. With the S&P 500 Index trading at a historically high valuation and not experiencing as much as a 5% correction this year, certainly valuation and time are not in the market’s favor right now. But these two factors by themselves should not be enough for a correction in stock prices to occur. After all, the earnings yield of the S&P 500, which is the inverse of the price earnings ratio, is currently nearly 5%, compared to the yield on the 10-year Treasury of only 1.34%. With such a yield advantage over bonds and with interest rates still near historic lows, an argument could be made that stocks remain more attractive than bonds and money market funds.  There has to be a reason for stocks to correct, but that reason is still not apparent.

Last Week

The producer price index (PPI) in August was slightly higher than expected but on a year-over-year basis, the PPI rose 8.3%, which is the biggest annual increase since the records have been kept going back to 2010. The increase raised inflation fears once again as supply chain issues are causing a shortage of consumer and producer goods at a time when there is strong demand during the pandemic. Weekly jobless claims were 310,000, below expectations of 335,000 and another new low since the beginning of the pandemic. The Job Openings and Labor Turnover Survey (JOLTS) showed that job openings (10.9 million) in July outnumbered the unemployed by more than 2 million.

For the week, the Dow Jones Industrial Average fell 2.2% to close at 34,607 while the S&P 500 Index lost 1.7% to close at 4,458. The Nasdaq Composite Index dropped 1.6% to close at 15,115.

This Week

The consumer price index (CPI) for August is expected to increase moderately but slightly less than in July while retail sales in August are forecast to decline by about 1%, in line with the drop last month.  The preliminary September University of Michigan consumer sentiment index is forecast to be slightly higher than in August, which was at the lowest level since December 2011.

The only notable company scheduled to report their quarterly earnings this week is Oracle.

Portfolio Strategy

After a weaker than expected August employment report and a hotter than forecast producer price index (PPI) earlier this month, investors will focus on the August consumer price index (CPI) and retail sales this week. This data comes at an important time for the markets as the Federal Reserve meets next week and is expected to discuss its plans to taper its $120 billion a month bond buying program. Consumer prices are expected to jump over 5% on an annual basis, well above the Fed’s target of 2%, and retail sales are forecast to decline again for the second straight month as stimulus money has dried up. If the inflation number is higher than expected and consumer spending is slower than anticipated, fears of stagflation may begin to creep into investors’ minds.  Stagflation refers to an economy that is experiencing a simultaneous increase in inflation and stagnation of economic output. It generally is also characterized by relatively high unemployment. Although many economists have reduced their economic growth forecasts for the third quarter, GDP is still expected to be above 5%. Consumer spending accounts for about 70% of economic activity and strong retail sales early in the year were the result of massive stimulus payments, the promise of vaccines and an increase in consumer optimism. With the rise in the number of cases of the Delta variant of Covid-19, consumer sentiment has fallen as concerns increase over a full reopening of the economy. Even though the August jobs report was disappointing, overall employment growth for the year has been fairly strong, which doesn’t fit the true definition of stagflation as unemployment has been coming down. In addition, the problem has not been demand but supply as shortages in consumer and producer goods have been caused by supply chain issues which should correct themselves over time.