The recent flare-up the COVID delta variant is a good example of how Mother Nature works to sustain her various biological creations. It is normal for viruses to mutate in order to survive and there will most likely be further mutations. With respect to the progress on COVID, it is clear we have made amazing strides over the past year, particularly the development of several effective vaccines, but the battle is far from over.
As we’ve discussed before, COVID and its outfall do have an important impact on the financial markets. This is because of the impact COVID can have on the economy.
As we saw last year, the COVID lockdowns resulted in massive unemployment and significant reduction in economic activity. This has a multi-pronged impact. For the bond markets, a slower economy usually means lower interest rates which, in turn, causes bond prices to rise. For the stock market, a slower economy or recession implies a reduction in corporate profits which are the primary driver of stock prices.
As you recall, the stock market experienced a severe bear market in March 2020 due to concerns over the recession and decline in corporate profits due to COVID. As a further layer of complexity for the markets, we have witnessed unprecedented intervention by both the Federal Reserve and the federal government (in the form of fiscal stimulus) to support the economy through the COVID recovery process. This intervention by both the Fed and the government has resulted in a massive injection of money (cash) into the financial system a lot of which we believe has found its way into the stock market.
Recently, we have seen a significant rise in cases and hospitalizations due to the delta variant. As a result, certain businesses and government bodies are mandating a return to wearing masks. This could be taken by investors as a negative sign that we are losing ground in the battle against COVID. Losing ground against COVID could then imply that future employment and economic growth could be slower than many now expect. This would have negative implications for the stock market (due to reduced earnings expectations) and positive implications for bond prices (due to lower interest rates).
The reality about re-introduction of mask mandates as it pertains to the financial markets is, as it has been since the beginning of the COVID episode: we don’t really know how bad it could get. Like everyone else, including the medical community, we are in uncharted waters and the virus could well take a turn that proves more negative than we now expect. And although we as humans cannot forecast the future, there are measures we can take as financial planners to reduce the risk of uncertainties stemming from COVID and the financial markets.
A couple of those things, which we do for every client, include determining an investment strategy that is appropriate for the client’s financial plan and risk tolerance, and employing asset class diversification to reduce portfolio risk.
Robert Toomey, CFA/CFP, is Vice President of Research for S. R. Schill & Associates on Mercer Island.