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Before The Bell - The month of October, which has historically seen some of the biggest market movements on record, got off to a productive start for stocks after a very rocky conclusion to September. The last fortnight of trading went to the bears, punctuated by two notable selloffs, one on debt concerns in China’s leveraged property market and the other by a worries about inflationary pressures stateside. However, on Friday the major averages, which turned in the worst monthly and weekly performances in September in quite some time, rallied on news from pharmaceutical giant Merck (MRK) that its antiviral treatment for COVID-19 has met success in trails. This quelled some of the recent worries in the investment community about the coronavirus Delta variant and its possible negative impact on the near-term performance of the U.S. economy.

On Friday, the rally was broad-based, with all of the major averages rebounding nicely after the early week setback. The Dow Jones Industrial Average, NASDAQ, S&P 500 Index, and Russell 2000 jumped 483, 118, 50, and 37 points, respectively. The pullback in Treasury yields from the earlier week high of around 1.55%, produced a relief rally in the high-growth sectors. The small-cap stocks led the move to the upside. That said…

We believe the inflation-trade stocks should continue to be of interest in the current market climate. The Friday retreat in bond yields aside, all signs point to prices and fixed-income yields moving higher over the remainder of this year and into 2022. The U.S. supply-chain disruptions and shortage of inventories—no place is this more prevalent than in the semiconductor industry—will likely continue to put pressure on wholesale and retail prices. 

A strong report on September manufacturing activity from the Institute for Supply Management on Friday also included numerous signs that the recent inflationary prices may prove a bit more than temporary. Although manufacturers’ inventories were growing, customers' inventories are currently too low, leading to a spike in prices. Given this backdrop, the more cyclical financial, energy, and materials sectors may perform well. Those groups also would get a boost if President Biden’s infrastructure plan is signed into law, but that remains fluid, given the contentious negotiations among lawmakers on Capitol Hill.

With earnings season still a couple weeks from commencing, Wall Street’s attention may center on Washington D.C., where a lot of unresolved issues persist, and another round of reports from the business beat. On the latter front, we will get some important—and possibly market-moving—releases, culminating with Friday’s report on labor market. This data may bring the monetary policy talk and when the Federal Reserve may begin to tighten the reins to the forefront. Before we get to that point, investors will receive data on nonmanufacturing activity (tomorrow at 10:00 A.M. EDT), the trade deficit, private-sector payrolls, and initial weekly jobless claims. 

Notwithstanding the nice rally to start the month, our sense is that volatility will remain the name of the game on Wall Street. The investment community still faces that proverbial “wall of worry” with a number of headwinds still in play, including the aforementioned inflation situation, a likely Fed tapering later this year, slowing growth in China, a contentious environment in the Washington D.C., and the ongoing COVID-19 Delta variant concerns. Given these uncertainties, investors may want to take a look at the stocks ranked 1 (Highest) and 2 (Above Average) for Safety by Value Line, as that group as a whole has historically fared relatively better than the broader market in stretches of heightened volatility. 

Before the bell, the equity futures are indicating some selling in the U.S. equity market after Friday’s rally. So far overseas, the trading has been negative, with the main indexes in China and Japan finishing notably lower overnight, while the major European bourses are modestly in the red, as trading moves into the second half of the session on the Continent. The bearish mood in the international equity markets is likely, due to continued worries about the debt crisis at China’s Evergrande (the property developer missed a scheduled interest payment to international bondholders last week) and slowing growth expectations for the world’s second-largest economy. – William G. Ferguson

At the time of this article’s writing, the author did not have positions in any of the companies mentioned.