The stock market suffered its largest one-day decline since October on Monday as investors appeared to be looking to the bond market and worried about growth.
The question for traders is whether it's creepy enough to trigger what many see as a long overdue sell-off, or whether it just gives the bulls one more dip-buying opportunity.
The rates market has "signaled growth concerns in recent months," said Marvin Loh, senior global markets strategist at State Street, in a telephone interview.
The main culprit on Monday was the delta variant of the coronavirus, which is causing COVID-19 and is responsible for the increase in infections around the world, including the US and other countries that have introduced vaccines. Fears of renewed travel restrictions and the further spread of the highly transferable variant, particularly among unvaccinated individuals, put pressure on travel-related stocks and other industries and sectors that had previously benefited from betting on cyclical companies, which are expected to be most of the economy will benefit from reopening.
At the bottom of the Dow Jones Industrial Average
fell 725.81 points, or 2.1%, to close at 33,962.04, the largest daily percentage and point loss since October 28th. The S&P 500
gave up 68.67 points, or 1.6%, and ended at 4,258.49 points during the Nasdaq Composite
lost 152.25 points, or 1.1%, to finish at 14,274.98 – the worst day for either index since May 12th. The Russell 2000 Small Cap Index
fell 1.5% to 2,130.68, avoiding a close in the correction zone at or below 2,124.15, a decrease of at least 10% from a recent high.
Distribute the blame
But it wasn't just the Delta variant to blame. Loh noted that the prospect of additional fiscal stimulus from Washington has stalled for some time. An earlier boost to reopening trade came after the Georgia Senate runoff in January, which gave the Democrats razor-thin control of the Upper Chamber and increased the prospect of President Joe Biden's adoption of aggressive fiscal measures.
Investors also cited US-China tension after the Biden government blamed Beijing for a hack into Microsoft Exchange email server software that compromised tens of thousands of computers around the world earlier this year. The European Union and Great Britain also pointed their fingers at China.
But after an initial win on a major spending plan, efforts to get a large infrastructure spending bill and plans for additional measures stalled, leaving only monetary policy in focus.
And while the Federal Reserve is in no hurry to withdraw its bond purchases or raise interest rates, a withdrawal of monetary stimulus is on the horizon. And other major central banks, including the European Central Bank and the Bank of Canada, are also trying to reduce stimulus measures, Loh said.
The delta variant "makes things a lot more uncertain about regression," Loh said, noting that "peak growth is something more that is talked about a lot more".
Meanwhile, long-dated US Treasuries and other developed market bonds have plummeted. Indeed, the decline in the 10 year rate of return is
which had risen to almost 1.8% in March, when growth expectations had skyrocketed and inflation fears mounted, then collapsed. On Monday it fell below 1.20% for the first time since mid-February. Returns and debt prices are moving in opposite directions.
For some investors, falling yields reflect waning inflation fears, with investors charging less premium to protect future coupon payments from inflation. Others, however, argued that Monday's decline in yields and price plunge pointed to mounting fears of stagflation, a term often associated with the 1970s mix of rising inflation and unemployment.
See: Why a bond rally could lower 10-year government bond yields even further, even if inflation expectations are abandoned
"The global economy is barely surviving on life support, and another wave of infections could trigger lockdowns that could signal the death knell for the weak recovery," Peter Essele, head of investment management for the Commonwealth Financial Network, said in an email.
"Fears of stagflation will be a major concern for investors if a resurgence of COVID infections causes the economy to slow while consumer prices continue to rise," he said. "The recent strong performance of inflation-indexed bonds could be an indication that these fears are setting in, since the bus has already left the train station."
Keep track of things
But others saw Monday's sell-off as long overdue as major indices hit all-time highs last week.
Indeed, the fact that Monday's declines were the largest in months may be more evidence of the lack of market volatility that accompanied the stock market rally. The S&P 500 has not retreated at least 5% from its recent high since late October, according to Dow Jones Market Data.
This is one of the longest stretches without such a retreat in the past decade, analysts from Truist Advisory Services wrote in a note. "Historically, we have seen two or three pullbacks of more than 5% a year, all of which have negative headlines," they noted.
In fact, an increase in volatility has accompanied rising concerns about COVID, and new variants have sparked an increase in volatility with the Cboe volatility index
in recent sessions jumped to trade above 22 late Monday after trading near 14 about two weeks ago, below its long-term average near 20.
This helps add to the weakness in stocks, Mike Lewis, head of US stocks cash trading at Barclays, said in email comments.
The jump in volatility means that “systematic” traders, especially trend-following commodity trading advisors, “take profits on recent equity gains, creating a large supply on a stock market with low summer volumes and no great liquidity background”.