Last week we touched on the fact that market internals have been deteriorating over the past six weeks. Eventually, broad-based relative weakness in small caps, mid caps and other sectors of the S&P 500 pulled the large market cap-weighted indices (SPY, DIA, QQQ) down nearly 4% over the span of four days. This concluded with a 2% swoon last Monday. The most watched index (SPY) ended sitting right on its 50-day moving average. Coincidentally, this occurred just as second quarter earnings season kicked off. I pointed out at that time that we needed to see buyers step in or we risked a long overdue drop of another 4-6%. Since then, buyers have stepped in as companies’ earnings rolled in beating both top- and bottom-line expectations. The last four days of last week saw stocks rebound and recover all of the losses, while falling bond yields found support and stabilized.
When it comes to the stock market, it is all about earnings. So far 24% of companies in the S&P 500 have reported and 88% beat estimates. These are good numbers and justify much of the run up in stocks since November. Falling bond yields do not. We have discussed bonds at length over the course of this year – when yields were rising and now when they are falling. Simply put, bond yields should rise over time as the economy strengthens and our country returns to full employment. The big jump in yields earlier in the year made sense as we saw hope for a return to normalcy around the world and pent-up consumer demand to buy, travel and live became palpable.
Right now, it seems we are at a crossroads and bonds yields and stocks are disconnected. This may be partly due to the inflation scare being overblown and commodity prices beginning to fall as supply has come back online. I am afraid that the other part of this story is the resurgence of Covid and the delta variant now spreading around the country in unvaccinated populations. We began to fully reopen our economy in late spring and that, as well as the concurrent growth in corporate earnings became “priced in” as stocks hit all-time highs. It is those earnings that are being reported now. As markets are forward looking, the question becomes, where do we go from here? Stocks are staying positive, but bonds are saying not so fast.
I have been traveling over the past week and I can tell you that things feel eerily similar to last summer. Masks are again required in Ubers, restaurants are limiting seating, people are wearing masks when walking on sidewalks, athletes are being disqualified from competition for positive Covid tests and news of hospitals filling up with sick and dying patients is back. To me, Covid remains our biggest risk going forward. In my opinion, for some reason Covid has become so politicized that many have missed the forest for the trees. Unfortunately, that is going to cause people to continue to get sick and die. The irony in all this is that eventually the right to not vaccinate will result in larger government mandates. The country cannot and will not let a minority threaten the lives and prosperity of the rest. We are beginning to see this in political rhetoric across the spectrum. Even the Governor of Alabama has come out and said, “blame it on the unvaccinated.” That small statement represents a tectonic shift. Increasingly, I suspect this roadblock will be confronted by state and federal intervention. This has already begun across various industries, starting with healthcare. Just as you can’t enroll your kids in school without proof of vaccinations, or even take your dog to daycare without evidence of their having updated shots, without proof of vaccination, we may not be able to work, travel, rent hotel rooms, eat in restaurants, use public transportation, or even apply for government benefits. I hope I am wrong, but this seems to be a real possibility if faced with the prospect of shutting down again. We will continue to watch as all this plays out.