By Hussein Sayed, Chief Market Strategist at Exinity Group
Following 54 record highs for the S&P 500 in 2021, momentum in equity markets has cooled slightly this week.
The slowdown in the economic recovery, rising Covid-19 cases and the high probability of central banks tightening monetary policies are all factors going against a market which is priced for perfection.
This week’s nervousness in equity markets is a sign that investors are beginning to reprice some of the known risks. Investors who are relying on central banks, particularly the Federal Reserve, may also need to have second thoughts, given the taper talk.
Jobs have been the number one priority for the U.S. Fed, and the 235,000 positions added in August was even below the most pessimistic forecasts.
However, on Tuesday we learned that job openings in the US rose to a record 10.9 million in July, according to the Job Openings and Labor Turnover Survey (JOLTS). There are currently more positions available than there are workers to fill them, and the asset purchases and tapering debate at the Fed is not going to solve this problem.
Virus fears, mismatch in skills and job requirements and enhanced unemployment benefits could all be factors for the current enormous gap between the supply and demand of workers. That said, unemployment benefits have now ended for millions of Americans, so there’s a high chance the upcoming October employment report could surprise to the upside.
Several Fed speakers have recently said that the current outlook supports a tapering announcement this year, including Dallas President Robert Kaplan and Bank of New York President John Williams. The hawkish tilt suggests a September taper announcement is still on the table when policymakers meet on September 21-22.
What worries markets not the beginning of tapering, but the trajectory of the virus and impact on economic growth. A further slowdown in economic activity means corporate earnings will decline, as will profit margins with continued increases in input prices.
The decline in the S&P 500 advance/decline ratio over the past several weeks also suggest a small group of stocks are leading the index higher, which is another warning signal.
No one knows when a big correction of 10-20% may occur and being out of the market has proven to be a bad strategy. However, investors need to be more cautious going forward, by reducing some risk in their portfolios or building some downside protection.
Focus on ECB
On Thursday, investors and traders will have their eyes on the European Central Bank meeting.
Economists believe the ECB will reduce its monetary support given the latest surge in inflation, but the bank will remain very accommodative. Markets are anticipating a €10-20 bln reduction in the pandemic emergency purchase programme from €80 bln a month at present.
However, the open-ended conventional asset purchase programme is likely to remain unchanged at €20 bln month. The ECB’s latest economic projections, tweaks in policy and President Lagarde’s tone will all be factors driving the euro from Thursday.
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