After an impressive 3 week run higher in the SP 500 Index to record highs into mid July as the seasonal charts expected, growing Bearish technical indicators were building for a market correction this past week. One of the prime triggers for the broad based selloff of 3 to 4% in the averages into the low on July 19th was due to the rise of Covid’s cousin, the Delta Variant. It’s very early to feel confident how this new upwave in the virus will evolve and how markets will react. Our sense is that while we expect fatalities from the virus to remain extremely subdued in relation to rising caseloads, the fear factor will be boosted by Government actions of alarm that will likely weigh on equities. For months we have been hearing about how bad inflation would be and stocks didn’t care. Now the Bond market tea leaves, as foretold by 10 Year yields plunging from 1.75% in March to 1.12% today, appear to elevate a fear that economic growth and inflation were over hyped and that the virus rebound could cause disinflation. Countries are restricting travel and adding new social distancing mandates again. In the US, where the Delta spread is still early, cities are also masking up and restricting air travel by the unvaccinated.
The highly vaccinated UK led 1st World countries in this new Delta virus upsurge. If their recent 7 week experience is any indication, Florida and the coming viral spread around the US should not fear the usual link to sharply rising fatalities. However, with Covid cases climbing now as we move closer to the return to school and to the workplace by Labor Day, there is risk that consumer expectations and consumption will peak along with investors turning more cautious.
Some indicators have been negatively influenced by Covid in recent weeks, such as Dow Theory. This is a technical indicator posthumously created from editorials written by Dow Jones and Wall Street Journal co-founder Charles Dow over a century ago. His co-workers’ compilation of Dow’s work postulated one of his tenets that a general stock market uptrend was vulnerable to a decline when an Index of Industrial stocks or Transportation stocks exceeded an important high without the other Index. This Dow Theory divergence sell occurred, as shown below, in mid June and mid July. Transportation stocks often lead a Bull market in broader stocks and they served as a tailwind last year as the delivery of goods for the stay at home economy surged. The Dow Transports continued to behave Bullishly until May as the Airline and Cruise stocks zoomed higher on reopening optimism as Covid faded. However, Covid’s Delta Variant has since begun spreading around the world including a recent uptick in the US. While US Transport companies began to falter in June, the broader stock market turned a blind eye to risk, much like the pre Covid climax in February 2020. By mid July, Virus concerns were rising in the US as this new Covid strain began popping up around the country along with new travel advisories and social restriction mandates. In order for transportation companies or the general stock market to rebound back to record highs it may require US cases of this new virus strain to run its course and turn lower.
Another classic Bearish technical divergence occurred at the recent record highs on July 12th. The Relative Strength Index (RSI) is a momentum oscillator that negatively diverged with its underlying SP 500 Index by moving lower in late April and early May as the SP closed at record highs. This led to a 5% correction over the ensuing 8 days into mid May. More recently from July 7th to 12th, the SP had a climax run to its current all time highs while RSI moved lower. So far prices have fallen a modest 3 to 4% from peak to trough, but until virus cases peak and interest rates reverse decisively higher, it will be hard for an equity rally to be sustained.
Interestingly, our use of Seasonal trends using various time periods has also warned of a July peak (blue dashed line below). Seasonality has been surprisingly timely this year and when added to other Bearish divergences it keeps us cautious into August and possibly September unless prices can reach all time highs and turn indicators Bullish.
Our compilation of important sentiment heavy indicators below had been warning of trouble in June. The good news here is that this longer term weekly chart perspective is already getting close to entering a modest oversold zone where investors can look to add stocks upon the next leg lower. The important 200 day moving average and ideal 10% correction level of the SP 500 Index are currently near 3900, which would be a more serious downside potential to be leary of until virus trends turn back down and economic reopening optimism can rebound.
The price chart below of the 10 Year Treasury with related yields posted is a key factor in gaging the virus and economic expectations. We have been a rare voice calling for falling yields this past month during this period of rising inflation that has confused virtually everyone. Our call for 1.2% to 1.3% and eventually 1.12% was reached much quicker than we expected. This 1.1 to 1.2% zone should offer a good bottoming zone for yields and a base from which reopening stocks where banking, travel and cyclical stocks can outperform. Some think the Bond yields are only falling due to Fed assets purchases, even though the Federal Reserve has been buying bonds (reducing supply) at a similar pace for the past year when yields rose from 0.5% to 1.75%. The Bond market is far larger than the stock market and seems to be rationally pricing in the ongoing global risk of Covid related waves that slow the full return of the labor force and discourage public travel, leisure and entertainment. As the 1st and 2nd tier countries finally reach average population vaccination levels near 50% by early Fall, there should be renewed optimism in reopening stocks, emerging markets and rising interest rates that send stocks back toward their record highs.