Before The Bell
The U.S. stock market, which started the week with the major indices at or near record highs, has been under selling pressure the last two trading days. The S&P 500 Index delivered its worst performance in over a month on Tuesday and, followed that up, along with the other major indexes, with another disappointing showing yesterday. The selling intensified into the closing bell and the U.S. equity futures are indicating that the move lower will continue today, with the Dow futures off more than 300 points this morning. The Federal Reserve minutes were part of a confluence of factors that prompted the profit taking and movement away from risky assets and into safe-haven instruments.
As noted, headlining the list of events that emboldening the bears are the minutes from the Federal Reserve’s July FOMC meeting. That report, released at 2:00 P.M. (EDT) yesterday, showed that Fed leaders were a bit more hawkish with regard to monetary policy, and that the central bank was preparing to taper its bond-buying program later this year, perhaps as early as next month’s FOMC meeting, but more likely at its late-November get-together, especially with concerns about the coronavirus’ Delta variant mounting. The readout showed that the Fed thinks the economy has reached its goal on inflation and it was closer to being satisfied with the progress of job growth. (On point, the Labor Department reported this morning that initial weekly unemployment claims fell to a pandemic-era low of 348,000.) The possibility of a more-hawkish Fed later this year, coupled with a 1.1% drop in July retail sales and a 7.0% month-to-month decline in housing starts, has taken a bite out of a market that entered the week looking priced for perfection.
The pullback in Treasury yields this week (the 10-year Treasury note fell nearly four basis this morning, to the 1.22% level) may suggest a few things, including that Wall Street is worried about growth and has some concerns about whether the U.S. economy can run on its own, absent of unprecedented monetary and fiscal support. This gives credence to sentiment among many market watchers that if the Fed acts too prematurely, it may create a taper tantrum and selloff; we are seeing such on just talk of the Fed pulling back on its support. The stubbornly low government bond yields are also be an indication that investors have a lesser appetite for riskier assets than they had just last week.
So what is an investor to do? The quick answer is to maintain a healthy level of stocks in their portfolios, as there are not a lot of other attractive invest alternatives right now. And with the financial system flush with liquidity and a lot of it still waiting on the sidelines, the bulls have the ability to step in quickly on any signs of selling, which continues to limit the near-term downside risk. (The S&P 500 Index has not seen a decline of 5% to 10% yet this year.) This backdrop was created by the Fed’s ultra-accommodative monetary policies and the unprecedented fiscal spending on Capitol Hill. For this reason, we think the Fed’s annual Jackson Hole, Wyoming meeting next week needs to be closely monitored, as it, along with Fed Chairman Jerome Powell’s prepared remarks, will provide more clues to the central bank’s timeline on tapering asset purchases and its perspective on interest rates.
In general, we would recommend looking at the stocks of the blue-chip companies with ample cash flows and strong balance sheets. These high-quality equities, particularly those ranked 1 (Highest) or 2 (Above Average) for Safety by Value Line, tend to perform better than the broader market during periods of heightened volatility. And with no particular equity group winning the game of sector rotation in recent weeks, we think it may be best to keep a balance of value and growth stocks in one’s portfolio.
The CBOE Volatility Index (or VIX), also known as the “fear gauge,” has jumped this week, climbing nearly 35% yesterday, and it is worth noting that the months of August and September have historically been volatile ones for those long equities. Wall Street doesn’t like uncertainty, and we have certainly witnessed some in recent days, including worries about what impact the Delta variant will have on the near-term performance of the U.S. economy, when the Federal Reserve will begin to tighten the monetary reins, and what impact the escalating geopolitical turmoil in Afghanistan will on the Middle East, a region that supplies many of the mineral and oil needs for the global economy.
Wall Street seems to be staring at the proverbial “wall of worry,” with many of the events noted above offsetting a spectacular second-quarter earnings season in which 88% of the S&P 500 companies have either met or exceeded expectations, and many doing so at a record pace. For the most part, this trend has continued this week, with strong reports from a number of the retailing giants, including Walmart (WMT), Target (TGT), Lowe’s (LOW), and The Home Depot (HD) in recent days. Department store chain Macy’s (M) continued that trend this morning, and its stock is pointing to a higher opening in down tape.
– William G. Ferguson
At the time of this article’s writing, the author did not have positions in any of the companies mentioned.
