The Delta Variant - What to Expect?
Badger Investment Group - Aug 19, 2021
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Few companies are keeping the S&P 500 at near-record highs due to investors' concentration in the mega-cap secular growth names. These holdings fuel the performance while most other stocks within are telling a different story.
The Delta variant of Covid-19 is creating a frightening deja vu in many countries that are critical to global supply chains, posing another risk to global markets. The high number of infections is forcing governments to take drastic measures to try and limit disruption.
In a recent update to its World Economic Outlook (WEO), the International Monetary Fund forecast emerging Asia will grow 7.5% this year, down 1.1% points from its previous projection made in April. That was a much more significant downgrade than a 0.4 point mark-down for emerging economies across the globe. Click here for the full article.
Since last year, China's most severe coronavirus outbreak has added to concerns over an economic slowdown in the country, as Beijing rushes to contain a rise in cases linked to the highly transmissible Delta variant. The outbreak is another challenge for Beijing after a series of recently published data and policy measures indicated that China's roaring economic recovery from the pandemic was under pressure.
China's factory activity expanded in July at the slowest pace in 17 months as higher raw material costs, equipment maintenance and extreme weather weighed on business activity, adding to concerns about a slowdown in the world's second-biggest economy. China's zero-tolerance approach could present significant downside risks to the current economic recovery.
North American Update
When looking at North American markets, two key indicators suggest we might see a correction in equities. First, we look at high yield credit. High yield credit represents the debt of companies that are at high risk of default. Bond investors tend to be more sensitive to default/credit risk. As a result, a high yield credit (HYG) tends to lead the S&P 500. Comparing these can give investors insights on what to expect in the short-term future.
As you can see above, HYG is breaking down, suggesting that stocks are in for a correction to the HYG level.
Another market metric that is pointing towards a correction is market breadth. Market breadth is a measure of how many stocks are participating in the market movement. As we stated a few weeks ago, few stocks are driving the S&P 500 to record highs. This phenomenon is hiding the true market story. If more stocks are dropping, this line falls; if more stocks are rallying, this line rises. As a result, it tends to lead the overall market at turning points since you will usually find fewer and fewer stocks rallying or dropping right before the top or bottom.
In this chart, we can see that breadth is correcting, again suggesting a drop in the near term future in the S&P 500.
Technical analysis is not always correct; we could see the breadth turn up resolving these divergences. Particularly, if we continue to see the monetary and fiscal support we have become accustomed to. However, both these charts warrant acknowledgment, as they suggest a correction to the 4,300 level on the S&P 500 could happen in the short-term. This coupled with uncertainty in China, and the global economies dependence on them, could lead to further downside risks.
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