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Delta COVID variant and the stock market

Will the Delta COVID variant impact the economic recovery and the stock market?

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Key takeaways

  • The Delta COVID variant may delay the full economic re-opening until 2022 as consumers stay home and businesses try to rebuild low inventories.
  • The economy is now in the mid-cycle, a phase of the business cycle historically characterized by broad economic growth and solid stock market performance though slightly diminished from the early cycle strength.
  • The fundamental cyclical backdrop for the stock market remains solid, including corporate earnings. A long-term financial plan can help you stay invested through uncertainty, now and in the future.

The Delta COVID variant is weighing heavily on the minds of many Americans. A measure of consumer sentiment in August showed that fewer Americans feel confident about the economy than in previous months. The University of Michigan's consumer sentiment index registered 70.2—down 13% from July and the lowest reading since 2011.

If you're wondering how the Delta variant could impact the economic recovery and the stock market, it's important to remember that economic fundamentals remain strong. Economic growth may moderate in coming months and stock market volatility could increase due to a confluence of factors including the rotation of the business cycle, struggling supply chains, and the increase in COVID cases in the US and around the world.

Read on for thoughts from Fidelity experts.

Delta COVID variant and the economy

The Delta COVID variant has already passed through countries including the Netherlands and the UK. Based on the experiences of those countries and others, some are hopeful that the increase in COVID cases in the US could peak relatively quickly and then fall.

"The good news and most important piece of information from the data emerging from the UK is that vaccinated individuals are still having strong protection against hospitalizations and death," says Karim Suwwan de Felipe, Ph.D., research analyst and portfolio manager of Fidelity Select Pharmaceuticals. His doctorate is in cellular, molecular, and biophysical studies.

As of mid-August, the Centers for Disease Control and Prevention (CDC) recommended a third dose of a COVID-19 vaccine for people with compromised immune systems such as those undergoing cancer treatment or organ transplant recipients. A third vaccine dose will be made available to the general population as soon as September—with the recommendation to get the booster 8 months after the second shot.

The CDC also recommends wearing a mask indoors in public in high transmission areas. It's possible that the Delta variant could put a damper on some economic activity—for instance, people may go to the movies less or out to restaurants less than they otherwise would.

As a result, "It's my view is that a full reopening will be delayed until sometime in 2022," Suwwan de Felipe explains.

But there is some good news. "Since the vaccinated population has strong protection against hospitalization and death, I believe that we are unlikely to go into the kind of restrictions that were imposed in 2020," Suwwan de Felipe says.

Delta COVID variant and stocks

Despite the grim news about increasing COVID cases, the fundamental factors that drive the stock market are actually doing pretty well.

"Q2 earnings season continues to be very encouraging," says Jurrien Timmer, director of global macro at Fidelity. "The year-over-year growth rate in Q2 estimates is up 40 percentage points (from the start of earnings season) to +94%."

Earnings are a key driver for stocks. Earnings took a nosedive in 2020 but 2021 estimates for earnings per share have now come full circle to pre-pandemic levels, Timmer says.

Dirk Hofschire, senior vice president of asset allocation research at Fidelity, agrees and adds some caveats.

"I would point to one encouraging near-term trend: Corporate profits have been rising even more quickly than stock prices. This implies the overall valuation of stocks has not been getting more expensive," says Hofschire. "It will be more challenging for profits to continue to outpace expectations going forward, but the cyclical backdrop appears reasonably supportive for corporate fundamentals."

"That being said, US stock valuations are still high compared to history, and a significant amount of good news is probably already priced in. Over the medium- to longer-term, it would make sense to moderate our return expectations from the outsized gains we've seen in recent years," Hofschire says.

Valuation vs. price/earnings

How to manage your portfolio through uncertainty

The Delta COVID variant is one of the many layers of uncertainty Americans are grappling with now—adding to unease over potentially shifting tax laws, growing inflation, and the uncertain path of the pandemic generally. It's at times like these that the importance of planning becomes apparent.

"The most common mistake people make is equating planning to investing. And really, without proper planning, investing becomes very reactive, which is exactly what you don't want to do," Fidelity wealth planner, Viktor Misko said in a recent Fidelity webinar, Planning during uncertainty.

To avoid reacting to the latest news, whether it's COVID or an unknown future issue, start with a plan centered on you that can help keep your investment life in perspective.

"Markets are always full of uncertainty—that is why having a tested investment process is so important. For many of our clients, we start with a diversified mix of investments that aligns to their financial plan. It starts with understanding their future financial goals, tolerance for risk, and overall financial situation," says Lars Schuster, institutional portfolio manager with Fidelity's Strategic Advisers.

Once the blueprint is set, outlining the essential asset allocation for your portfolio in terms of the percentage of stocks, bonds, and short-term investments, the portfolio is managed with an eye to the business cycle.

"Over the last few months the economy has moved on from an early cycle recovery, a period that was very favorable for US stocks, particularly value and small-caps. That's why in most well-diversified client accounts, we have modestly reduced exposure to US stocks, and shifted to developed international stocks, which are a little behind the US in terms of recovery," says Schuster.

Where are we in the business cycle?

The US economy is in the mid-cycle phase according to the recent business cycle update from Fidelity.

"The mid-cycle phase is characterized by a broadening economic expansion and is typically the longest phase of the business cycle," Hofschire says.

"Over the full phase, economically sensitive asset classes such as stocks tend to perform better than more defensive assets such as bonds. However, stock market corrections—declines of 10%—happen periodically, so portfolio diversification remains important," he says.

With the heightened uncertainty around rising COVID cases in the US and elsewhere, plus other unforeseen events around the world, it's a good bet that the stock market could get rocky in the coming weeks and months. It's important to remember that stocks trend upward over time, but don't necessarily move up in a straight line.

"Market events are normal. So as an investor, you have to ask yourself, is this event or news going to change the pace of economic growth, direction of earnings, or valuations? If those factors are still intact, it's probably going to be OK. You may want to take the opportunity to rebalance," Schuster says. "Ultimately, this is where diversification can be your friend. If you're diversified that may help smooth out the ride."

If you aren't sure if your plan aligns to your current goals and financial situation or if you need help developing a financial plan designed for the long term, Fidelity can help.

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