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By Pete Biebel, Senior Vice President

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The market was juggling several significant concerns as last week began. In addition to the growing threat of the Covid Delta variant, the market suddenly had a couple new balls in the air: Afghanistan and a slowing economy in China. Stocks opened lower last Monday, but the market quickly regained focus and was able to ignore the distractions and resume its performance by climbing to slightly higher new highs on both the Dow Jones Industrial Average (DJIA) and the S&P 500 Index (SPX) later that day.

The market was thrown another curveball on Tuesday when the Commerce Department released its Retail Sales report for July. The report showed a surprising decline of 1.1%; the consensus expectation had been for just a 0.3% decline. Stocks opened sharply lower on the news and continued lower through the morning. The major averages were again able to rebound through the afternoon, but nevertheless ended the day with losses of about 0.8%. One insight that likely reduced the impact of the bombshell report is that potential July retail sales had been pulled forward into the month of June. Recall that a major retailer held its Prime Day sales event in June this year. Most other large retailers staged similar competing sales events that month. The combined effect of those sales was to ring up colossal revenues in June that might otherwise have been spread out over the coming months.

The stock market’s bungle came on Wednesday. Activity was fairly low-key through the morning hours as traders awaited the release of the FOMC meeting minutes that afternoon. There had been increasing evidence that several of the Committee’s voting members favored beginning to taper the Fed’s asset purchases in the coming months as opposed to waiting until 2022. The meeting minutes would provide a more accurate picture of how likely an acceleration in that process might be. The averages see-sawed briefly following the release of the minutes, but then skidded sharply lower in the final two hours of the session.

The averages gapped lower Thursday morning but hit what would prove to be their lows of the week in the opening minutes that day. An on-again, off-again rebound through the remainder of the day and an all-day rally on Friday helped investors forget about the mid-week bobble. For the week, SPX had a net loss of 0.59%, the NASDAQ Composite Index (COMP) slipped 0.73% and DJIA lost 1.11%. The Russell 2000 Index of small-cap stocks (RUT) really dropped the ball, but more on that later.

Five of the eleven S&P sectors managed small gains for the week. Healthcare led them all, climbing a wholesome 1.81%. Lower interest rates in a rallying bond market helped Utilities (+1.72%) and Real Estate (+0.43%), while Technology also had a relatively good week, up 0.48%. The decline in interest rates also led to a discount on stocks in the Financials sector. That sector had gained nearly 11% in four successive positive weeks and set a new high as of the previous Friday, but it lost 2.38% last week.

The U.S. Dollar had its second-largest weekly gain in a year. Increasing geopolitical tension is usually good for the Greenback. We can see the impact of the stronger Dollar in the list of the underperformers from last week. In Dollar terms, most international equity indices had significant losses for the week. The British Pound, the Canadian Dollar and the euro currency also stumbled. And many commodity sectors suffered price declines.

Commodities in general were probably overdue for a fumble after carrying the ball higher for more than a year. The commodity index that I watch nearly doubled from its late-April 2020 low to a five-year high last month. That index sank more than 6% last week. One commodity that no doubt lubricated that slide was crude oil. WTI crude had climbed into the mid-$70s early in July and was just below $74 at the end of the month. It’s been much less robust in August, trending steadily lower. Crude was trading near $68 per barrel early last week, but ended the week at $62.25, its lowest level in four months. Consequently, oil company stocks also tanked; the S&P Energy sector index was down more than 7% for the week.

I think there’s a three-fold message in the way stocks reacted to the news last week. Probably the most significant of those is that the market is not worried about the Fed’s impending tapering. We all know it’s coming. The only issues are how soon and for how long. After last week’s developments, the market seems to expect tapering to begin late this year, earlier than had been advertised. The consensus seems to be that, once started, the tapering will stretch over 12 to 18 months. That means that the Fed will continue providing liquidity and expanding its balance sheet for at least the next year. The free money made available by the Fed and fiscal stimulus has been one of the key drivers inflating asset prices. While the size of those flows will decline, they will be positive for a long time to come.

Second, the market’s concern over the spread of the Covid Delta variant hasn’t yet become a negative. The market is watching but not yet worrying. Experts estimate that the current wave of infections will peak in the next several weeks. Expect the market to be a lot more worried if the rate of spread of the virus is at current levels or higher next month. Third, the attitude toward geopolitical unrest seems to be similar. Again, the message seems to be “watching but not worrying.”

To me, the bigger message from the market last week was on a technical level. After hitting a new high on Monday, SPX fell below its low of the previous week on Tuesday. When that low was taken out Wednesday afternoon, it triggered a rush for the exits. The follow-through selling the next morning forced SPX down to near its 50-day moving average.  When that level held, it inspired the dip buyers, and SPX was able to recover all of its post-Fed minutes losses by the end of the week. The damage midweek was the first technical threat in more than a month.  It marked the ninth time SPX has tested its 50-day this year. COMP also tested its 50-day last week. It has now clearly broken its short-term uptrend. Along with the continuing deterioration in market breadth, the weakening technical picture is hinting that the next month or two are likely to be more hazardous than the first eight months of the year.

SPX ended last week near 4442, about 1% below last Monday’s record high. Given last week’s late strength, a run back up to that level wouldn’t be unusual, but I don’t expect SPX will get much beyond 4490. The critical area to watch is in the range of last week’s low and the 50-day moving average; call it 4350 to 4365. Sustained trading below that level could very likely spark a steep short-term decline.

One area to watch as an early warning sign is whether the relative strength in the mega-cap tech stocks continues. As a group, they’ve been able to pull the averages to new highs even as fewer and fewer stocks were participating in the rallies. If some of those big names begin to perform more poorly, that would probably be a bad omen. A second area where weakness might foretell some trouble for the overall market is small cap stocks. You might have seen that RUT had a big day on Friday, gaining 1.65%. However, it still had a net loss of 2.50% for the week. That index not only has fallen away from its March high, but it has also been trading below its 50-day moving average since early-July. At its low last Thursday, RUT was below its 200-day moving average and approaching the 2100 level, a level that has been the bottom of a six-month trading range. If RUT stumbles and falls below 2100, then watch for that weakness to spread to larger-cap stocks.

If there will be any significant messages in economic data this week, they will likely come from the Durable Goods and/or the GDP reports. Traders will also be listening closely to FOMC Chairman Powell’s address on Friday at the Fed’s virtual Jackson Hole conference.

Date Report

Previous

Consensus

Monday 8/23/2021

Chicago Fed National Activity Index, July

0.09

0.10

PMI Composite Flash, August

59.7

59.5

Existing Home Sales, July, SAAR

5.860mm

5.830mm

Tuesday 8/24/2021

Unit Labor Costs, Q2, SAAR

1.7%

1.2%

New Home Sales, July, SAAR

676K

700K

Richmond Fed Manufacturing Index, August

27

25

Wednesday 8/25/2021

Durable Goods Orders, July, M/M

+0.8%

-0.2%

Durable Goods ex-Transportation, July, M/M

+0.3%

+0.5%

Thursday 8/26/2021

Initial Jobless Claims

348K

340K

GDP, Q2, SAAR

+6.5%

+6.6%

Kansas City Fed Manufacturing Index, August

30

30

Friday 8/27/2021

International Trade in Goods, Trade Deficit, July

$91.2B

$90.9B

Personal Income, July, M/M

+0.1%

+0.5%

Personal Consumption Expenditures, July, M/M

+1.0%

+0.5%

Wholesale Inventories, July, M/M

+0.8%

+0.9%

Consumer Sentiment, August

70.2

70.9

 

Links to previously published commentaries can be found at benjaminfedwards.com/For Our Clients/Educational Resources/Market.

August 23, 2021 |