Optimism Holds as Summer Fades, But Can it Continue?
Through much of July, the financial markets seemed as confused about the future of the economy as the rest of us were about the coronavirus. Investors seemed giddy with optimism one week, wary the next week, then giddy again. That’s how most of us are feeling about the pandemic as Covid-19 variant cases spike, and politicians send mixed messages about how cautious we should or shouldn’t be. How will this confusion play out as Summer gives way to Fall?
That’s a good question considering Labor Day is just a few short weeks away. However, before we look forward, let’s look more closely at the past month, which started with all three major market indexes—the Dow, S&P 500, and Nasdaq—hitting new record highs. They all surpassed those peaks again by mid-month. Then came the week of July 15th, which saw sharp declines across the board and ended with all three indexes in the red.* The drop was blamed on new concerns about inflation, which until recently seemed to be the only issue capable of even slightly spooking Wall Street.
I say “until recently” because after rebounding to new peak highs by late July, the markets dropped slightly again to end the month, and this time inflation wasn’t the culprit. It was the Covid-19 issue and worries over the extent to which the stubborn virus could start to negatively impact the economy again. After the CDC revised its masking policy to recommend that both unvaccinated and vaccinated people wear masks indoors, several major retailers retightened their own policies. Heading into August, concern about the virus was strong enough to overshadow a new batch of better-than-expected quarterly earnings reports and keep the markets muted.**
In a way, the spike in Covid-19 variants is a double-edged sword for Wall Street. On one hand, if mask mandates and other restrictions tighten further, it could slow the pace of growth just enough to finally eliminate inflation as a concern. In other words, if tighter restrictions lead to fewer shoppers, travelers, and ticket-buyers again, the drop in demand could hold rising prices in check. On the other hand, if demand drops by too much and the recovery completely stalls, investors could start worrying about the whole economy reversing course.
There are other issues that could have major market impacts in the coming weeks as well. As always, one is the Federal Reserve. Will the Fed stick to its ultra-supportive monetary policy when it meets in September? Or will it shift gears by raising short-term interest rates again, perhaps also pulling the plug on some of its quantitative easing? That’s an important question because the markets are still influenced more by Fed policy in many ways than by economic fundamentals. As for long-term interest rates, they fell further in July, with the yield on the 10-Year Treasury rate starting August at 1.17%—its lowest level since February.*** That shows pretty clearly the bond market has a much less optimistic view of the future right now than the stock market does—which only adds to all the confusion.
So, what does all this mean for income investors? It means it’s important to continue heeding the lessons we learned from the coronavirus crisis the first time around. Those lessons include making sure your financial plan is providing you maximum protection and adequate flexibility. While the Income Model is designed to check both those boxes, if you haven’t reviewed your plan in a while, now is a perfect time to do so. With so much uncertainty brewing, you want to make sure your strategy is as defensively strong as it should be should things go south. At the same time, you want to make sure it’s flexible enough to allow you to take advantage of any potential new opportunities that may arise if things restabilize and strengthen.
Don’t Trust ‘Autopilot’
That isn’t to say that things are “weak” right now. Compared to a year ago, we’re obviously in great shape. In regards to the stock market, as of August 3rd U.S. stocks had gone 180 trading days without a pullback of at least 5%—one of the longest such stretches in history, according to Goldman Sachs.** However, that’s both the good news and the concerning news, especially when you consider the market is overvalued and probably overdue for another correction of at least 10% or more.
The bottom line is that as Covid-19 continues trying to regain strength and the markets continue looking for direction, I urge you to continue trying to maximize the value of your income strategy. Again, that means reviewing it if you haven’t recently to make sure it’s still providing enough protection and giving you the greatest opportunity to increase your income. Remember, no financial strategy should be left on autopilot, especially at a time when conditions are growing turbulent and forward visibility is low.
*“Dow Drops Nearly 300 Points on Friday,” CNBC, July 16, 2021
**“Stocks Turn Lower as Virus Concerns Outweigh Strong Earnings,” Yahoo Finance, Aug. 3, 2021