A trader works on the New York Stock Exchange (NYSE) in New York on August 20, 2021.
Andrew Kelly | Reuters
The markets: it's August, but it's also Covid. Normal trade flows in August are made more difficult by the delta variant.
A third, but still important, complication – increasingly authoritarian action in China is causing some to reassess China's demand for raw materials and the valuation of its entire market.
A normal August
At one level, this is a normal August: mostly low volume followed by brief bursts of downward volatility.
Many were alarmed when the Cboe Volatility Index (VIX) hit close to 25 on Thursday morning, but that's just because volatility was unusually low, with only a few 1% daily moves in the S&P 500 over the past few months (well below the historic Average, about one a week).
It is typical for the VIX to rise at least once – and often multiple times – in August and September and even into October. Last year it was 25 at that time and the 40s in October:
VIX: last Aug.-Oct. Heights
August through September is typically strong for defensive sectors like consumer staples, healthcare, utilities and weak for cyclicals like energy, materials and industrials and "less positive" for technology, according to BofA Securities.
So far, that's exactly what has happened.
Not a normal August
On another level, this is not a normal August at all.
The main driver of the market (the reopening story) is being re-evaluated. Due to the delta variant, the market is forced to reassess its growth prospects.
As a result, cyclical sectors sensitive to the reopening will be hit this week (Energy, Materials, Industry, Travel / Leisure):
Energy this week:
EOG resources: -6%
Cabot oil -8%
Industry / Materials this week:
United rentals: -6%
Freeport McMoRan: -15%
Cleveland Cliffs: -10%
Airlines this week:
United: down 6%
American: down 6%
Delta: down by 5%
The broader market is holding up due to the continued rotation into defensive stocks (healthcare, consumer staples, utilities) and technology, where several megacap names are making new highs.
Staples this week:
Costco: up 1.4%
Pepsi: up 1.7%
Kimberly-Clark up 1.8%
Procter & Gamble: up 0.8%
Health care this week:
Abbott: up 2%
HCA: increased by 1.5%
United Health up 1%
Bristol-Meyers: plus 1.7%
Technology new heights:
Is the Fed now the marginal mover of the market?
Given the fragile markets, some believe the Fed has now become very important as a wild card. Markets are happy with a possible announcement of a tapering schedule in September, with tapering starting at the end of the year and ending sometime in the middle of next year, followed by rate hikes.
However, should this suddenly change, the markets could get excited and unable to handle previous tapering and rate hikes, as well as the delta option, all at once. A sudden move to a higher interest rate position is historically the big killer of bull markets.
Traders have stressed the need for the Fed to carefully manage their message – if it doesn't and rates suddenly rise, the technology will sell out dramatically and the now modest 2% correction quickly turns into a 10% defeat.
Delta variant remains the great unknown
Which is the bigger problem? Both are at play, but most believe that Delta is the greater of the two risks, as the effects of the Delta variant are far less predictable than the likely path the Fed will take.
Bulls insist that economic activity resume at full throttle once everyone gets boosters.
But there will be several months when the outcome is uncertain. Until then, it's like death by a thousand cuts.
"The worse the delta gets, the more likely it is that the taper will start later rather than earlier," said Alec Young of Tactical Alpha.
"Either the delta will subside and the Fed will start to taper, or the delta will get out of hand and the Fed's schedule could change," he added. "Investors would much rather deal with a well-wired taper than an out of control delta expansion and calming the global economy."