Markets On Edge
Evergrande default possibilities sets markets on volatile trading this week.
Fed on track to start Tapering later this year.
Economic metrics vary, but U.S. recovery still on track.
COVID cases ease, reducing probability the virus will derail future growth.
Things got interesting this week when news about Evergrande, the Chinese real estate company, would default - at least partially - on their debt. Valuations were stretched, which allowed the possibility of contagion to hit markets harder than it probably should have. As Don Henley once sang, "In a New York minute, everything can change." Markets quickly recovered, especially after the Fed provided more room until tapering begins. Here's what we're seeing so far this week.
What Set Markets Off Early This Week? On Monday, the S&P 500 Index sold off almost 2% due to concerns over Evergrande and the possibility that the company would default on its debt. A payment on $83.5 million in bonds was due last night at midnight and bondholders have still not been notified as to the likelihood of payment. Technically, the property group has a 30-day grace period before the bonds are officially in default. However, the company still has total obligations of over $300 billion. This set off a chain reaction of worry on Monday about contagion - both within the Chinese markets and globally. The Chinese central bank has stepped in to offer both liquidity and potential restructuring. That helped markets settle down, and with the Fed putting off tapering for a couple of months (more on that later), markets are now trading in positive territory for the week. Once again, the S&P has hit or exceeded the 50-day moving average, only to rise above the metric - having done so 9 times this year. The index did the same thing back in early March, selling off a little more than 4% from peak. Monday's sell off took the index down almost 4% from the September 2nd peak.
Fed Meeting Goes Pretty Much As Expected. The Fed once again left themselves room to maneuver on tapering and interest rates. The Fed did not officially announce Tapering, but basically pointed to Tapering being announced at their next meeting on November 2nd & 3rd and beginning in December. Asset purchases are expected to end by the middle of 2022. Some of the language inserted into the Fed's FOMC statement makes the case that the U.S. economic recovery is still well underway. According to the release of Wednesday's FOMC meeting, "if progress continues broadly as expected, the Committee judges that a moderation in the pace of asset purchases may soon be warranted." The delay in Tapering until November helped fuel the recovery in stocks this week. Meanwhile, the yield on the 10-year Treasury rose on Thursday and is higher by 4 basis points on the week. Bonds may be beginning to adjust to life after Tapering. In addition, the "dot plots" seem to be pointing to at least one rate hike in 2022, which is counter to the Fed's view that they would not raise until 2023. Inflation could be the key as to why that has changed. Now, nearly all FOMC members view Inflation as a key headwind going into next year. As we have noted before, Inflation is not appearing to be "transitory" and the Fed members are slowly coming to this conclusion as the Fed's own Inflation expectations were revised higher from 3.0% in June to 3.7% for 2021 and higher in 2022 & 2023. In conjunction, the Fed Funds Rate was also moved higher from June projections. Some market pundits and economists are calling for lower Inflation next year. The problem we see with that is that too many consumers are chasing too few goods and the labor market is improving. As long as consumers have plenty of money in their wallets, the speed of money does not seem likely to slow down. It could moderate and flatten, but we don't hold the view that Inflation is going lower in the near term. Fed Chairman Powell is expected to speak at an event at 10 am eastern, so we could always get a move in the markets depending upon the Chairman's mood today.
Economic Releases Mixed, But Improving - As Noted By The Fed. Ever since extended unemployment benefits related to the pandemic ended over the Labor Day weekend, we've been watching Continued Jobless Claims to see if that is having an effect on people re-entering the workforce. So far, the results are mixed. Continued Claims are down 2.2% since August 26th, just prior to the Labor Day weekend. However, the weekly numbers have been up and down. Initial Claims have disappointed the last couple of weeks, after hitting a post-pandemic low of 310,000. Both the Kansas City Manufacturing Index and the Chicago Fed National Activity Index moved lower month-over-month. Housing data, including Starts, Existing Home Sales, and Building Permits all improved in August. The flash reading of the Markit Manufacturing & Services indices slightly disappointed market expectations, but both remain comfortably above 50, indicating expansion. Most important, after sifting through the "trees" to see the "forest," the overall economic picture remains stable. The Chicago Fed's National Financial Conditions Index remained stable. Moreover, our Wealth Protection Signal, while slightly elevated after Monday's market action, settled down by Wednesday and is now back below the levels seen by the end of last week. An important lesson in market timing - never take losses right away as selloffs can be very temporary in nature. And, our Wealth Protection Signal verified that as it never got close to indicating it was time to move to cash as a defensive measure. Investors who sold out on Monday only locked in losses that, by Thursday, were all but eradicated.
COVID Still Out There - Can It Derail Growth? While COVID is still a concern in certain areas, we do not see it derailing the recovery or significantly slowing growth going forward. If we look at the latest trendline for positive COVID cases in the U.S., the trendline is clearly downward sloping. The latest wave of Delta cases never reached the highs of the Fall '20 / Winter '21 wave. Testing for COVID ramped up during this latest wave, with peak tests equaling 2.9 million daily versus the peak of 2.3 million in January. In fact, positive case rate has dropped to 7.9%, a level not seen since July 25th. Also encouraging is the decline in hospitalizations. First, hospitalizations COVID never reached the highs of January. Current COVID hospitalizations from the Delta variant peaked 4 weeks ago at 26,087, which is 10.5% lower than the January peak. Over the past few weeks, hospitalizations have declined 9.3%. Lastly, the reproduction rate of COVID has declined substantially. The maps below show the peak reproduction rate on July 11th - a map that is mostly red (high rate of reproduction) and the map from September 22nd which is mostly black (low rate of reproduction. Based on all of this data, our view is that COVID is cycling down and, while it will likely be with us forever, does not pose further serious risks to the U.S. economy.