The markets: it’s August, but it’s also covid. Normal August trading flows are being greatly complicated by the delta variant.

A third but still important complication: increasingly authoritarian action in China is causing some to reprice China’s demand for commodities, and the valuation of its entire market.

On one level, this is a normal August: mostly low volume, followed by short bursts of downside volatility.

Many were alarmed when the CBOE Volatility Index (VIX) hit almost 25 Thursday morning, but that’s only because volatility has been abnormally low, with only a few 1% daily moves in the S&P 500 in the last few months (way below the historic average, which is about one every week).

It’s very typical for the VIX to spike at least once — and often several times — in August and September, and even into October. It was 25 at this time last year, and spiked into the 40s in October:

VIX: recent Aug-Oct. highs
2020 41
2019 24.8
2018 28.8

August to September is typically strong for defensive sectors like consumer staples, health care, utilities, weak for cyclicals like energy, materials and industrials, and “less positive” for technology, according to BofA Securities.

So far, that is exactly what is happening.

On another level, this is not at all a normal August.

The primary mover of the market (the reopening story) is getting re-rated. The market is being forced to reprice the growth outlook due to the delta variant.

As a result, cyclicals sectors that are sensitive to the reopening story (energy, materials, industrials, travel/leisure) are getting hit this week:

Energy this week:
Chevron: -8%
EOG: -6%
Hess -10%
Cabot Oil -8%

Industrials/materials this week:
Deere: -6%
United Rentals: -6%
Caterpillar -6.5%
Freeport-McMoran: -15%
Cleveland-Cliffs: -10%

Airlines this week:
United: down 6%
American: down 6%
Delta: down 5%

The broader market is holding up due to the continuing rotation into defensives (health care, consumer staples, utilities) and technology, where several megacap names are hitting new highs.

Consumer staples this week:
Costco: up 1.4%
Pepsi: up 1.7%
Kimberly-Clark up 1.8%
Procter & Gamble: up 0.8%

Health care this week:
Abbott: up 2%
HCA: up 1.5%
United Health up 1%
Bristol-Meyers: up 1.7%

Technology new highs:
Cisco
Microsoft
Adobe
Juniper Networks

With the markets fragile, some believe the Fed has now become very important as a wildcard. The markets are comfortable with a September announcement of a tapering timeline, with tapering starting at the end of the year, and ending sometime in the middle of next year, with rate hikes starting after that.

But if that were to suddenly change, the markets could go into a tizzy, unable to deal with earlier tapering and rate hikes and the delta variant all at once. A sudden move to a higher rate stance is historically the Great Killer of Bull Markets.

Traders have emphasized the Fed must carefully manage its message — if it does not, and rates rise suddenly, tech will sell off dramatically and what is now a modest 2% correction will quickly turn into a 10% route.

Which is the bigger issue? Both are in play, but most feel delta is the bigger of the two risks, because the delta variant impact is far less predictable than the Fed’s likely path.

Bulls insist that once everyone gets boosters, full-steam-ahead economic activity will resume.

But there’s going to be several months where the outcome is uncertain. Until then, it’s like death from a thousand cuts.

“The worse delta gets, the more likely tapering will start later rather than sooner,” Alec Young from Tactical Alpha told me.

“You’re either going to have delta ease up and the Fed start tapering, or delta will get out of control and the Fed timeline could change,” he added. “Investors would much rather deal with well-telegraphed tapering than they would with delta spreading out of control and tanking the global economy.”