How the nervousness of the global economy affects the markets

Monday’s pullback put a dent in that narrative. The Dow Jones Industrial Average fell 725.81 points, or 2.1%, to 33,962.04, posting its biggest drop since October. Meanwhile, the yield on the 10-year U.S. Treasury bill, which falls as bond prices rise, fell to its lowest level since February. And US crude oil prices fell 7.5%, marking their worst session since September.

Behind the rout, investors say, lies a growing list of concerns about the recovery. The Delta coronavirus variant has spread quickly, rekindling debate in several countries over whether governments should resume shutdowns and curb activity. Meanwhile, inflation has accelerated faster than expected, and strained U.S.-China relations have put pressure on trillions of Chinese companies listed in the United States.

Many fund managers believe that the global economy can continue to grow. They just don’t know how fast and if the gains will be enough to keep markets getting more expensive after a record first half.

“The market says the economy is going to slow down quite significantly in the coming weeks or months,” said Zhiwei Ren, portfolio manager at Penn Mutual Asset Management.

Maximum growth?

Investors say much of what led to the market reversals on Monday was fear that the best of the economic recovery was in the rearview mirror.

The 2020 recession in the United States lasted just two months, the shortest on record, according to the National Bureau of Economic Research. The economy grew in the following year.

Gross domestic product grew at a seasonally adjusted annual rate of 6.4% from January to March, leaving the United States less than 1% of its peak reached in late 2019.

Economists polled by the Journal estimate that the economy grew at a seasonally adjusted annual rate of 9.1% during the period from April to June, the second fastest pace since 1983. Corporate profits are also on. the point of soaring. Analysts predict profits of S&P 500 companies will rise nearly 70% in the second quarter from a year earlier, a growth rate that is believed to be the highest in more than a decade.

Now some investors are asking: is this as good as it gets?

Economists believe the pace of U.S. growth this year likely peaked in the spring and will moderate to 6.9% for 2021 as a whole before cooling to 3.2% next year and 2.3% in 2023. These downside expectations have fueled big moves across stocks and sectors within the S&P 500 as well as in the bond market.

“That’s what the market did… by starting to digest growth spikes and realizing that those growth rates are unsustainable,” said John Porter, director of equity investments at Mellon Investments Corp.

Elsewhere in the world, growth also looks set to slow, which could indicate new challenges for investors. The S&P 500 continued to outperform the Stoxx Europe 600 and the Shanghai Composite over the year. However, some investors are wondering if the gap between the US and foreign indexes will narrow, if the recovery in the US begins to slow further.

Oil prices fall

One area of ​​the markets where fear of growth quickly emerged: the oil market.

For months, investors had crammed into bullish bets on oil, assuming demand would rise and the economy would experience a robust recovery. Many of these bets have been settled in recent sessions. Monday’s declines were driven by fears that the Delta variant would interrupt travel and reduce fuel demand.

Equities of energy producers, who tend to be sensitive to changes in the economic outlook, also retreated. The energy sector of the S&P 500 is now down 13% this month, the worst performing group on the index.

Feelings stands

For months, people in the United States have opened their wallets and spent on everything from cars to travel. Investors have become more optimistic about the economy, as Americans get vaccinated, businesses reopen and many people find themselves full of cash, helped in part by stimulus checks. A survey by Gallup showed that the percentage of Americans who considered themselves “successful” in life was 59.2% in June, the highest in more than 13 years.

Recently, signs have emerged that this optimism is starting to wane. New data from last week showed consumers increased their spending in June. However, new figures also showed that consumer confidence in the United States fell in early July, falling short of the expectations of economists polled by The Wall Street Journal. Meanwhile, the unemployment rate has stagnated and some investors are now worried about a labor shortage plaguing the economy.

One of the main factors weighing on sentiment? Inflation. Consumer complaints about rising prices for homes, vehicles and durable household goods have reached an all-time high, particularly affecting low- and middle-income households. The Labor Department said its consumer price index rose 5.4% in June from a year ago, the fastest 12-month pace since August 2008.

Since consumer spending is the engine of much of US economic growth, investors tend to pay attention to signs that households are starting to be suspicious of large purchases. Inflation can also eat into corporate earnings, making stocks less attractive.

“Last week we had high inflation readings. We are now concerned that the increase in Covid cases may cloud the economic outlook. High inflation and lower economic growth is not a good combination, ”said Dave Donabedian, chief investment officer of CIBC Private Wealth Management, US, in comments sent via email.

The bond market warning

Even before Monday, bets on slowing economic growth spilled over into the bond market. Investors have been gobbling up government bonds for weeks.

An effect of the fall in bond rates? The real yield on 10-year Treasuries was negative and slipped to 1.05% on Monday, the lowest since February. Real returns are what investors get on US government bonds after adjusting for inflation. When these bond yields are negative, as they have been in recent times, investors actually run losses when they put their money in government bonds.

“People are worried about inflation but also about a fear of growth,” said Giorgio Caputo, portfolio manager at JO Hambro Capital Management. “You have never had a modern economy that reopened after a pandemic.”

These fears have led investors to turn to government bonds and have helped drive those real yields further down, he said.

While the unfavorable growth outlook is generally negative for stocks as a whole, one sector of the market has actually benefited from negative real returns. Lower returns weigh on the discount rate in the formulas used to estimate what stock prices should be, making future company profits more valuable. The recent drop in yields has boosted stocks of tech companies and other fast-growing companies and helped drive a gigantic shift in the stock market in recent weeks. Tech giants like Apple Inc.,

Amazon.com Inc.

and Microsoft Corp.

reached new heights, even as many other parts of the market collapsed.

And on Monday, the Nasdaq Composite outperformed its peers. Many investors have gone back to the bets that flourished when people across the country were stranded in their homes during the Covid-19 pandemic. Interactive Platoon Inc.

stocks jumped 7.1%, while Slack Technologies Inc.

added 1%. Wayfair Inc.

stocks rose 3.3%.

In contrast, stocks of cyclical companies enjoying a faster economic recovery, such as banks, energy companies and airlines, have been among the worst performers in the stock market.

“It looks like the market has overextrapolated the good times… and now we’re seeing a little bit of air escaping,” said Jason Pride, director of private banking investments at Glenmede.

Write to Gunjan Banerji at [email protected] and Akane Otani at [email protected]