Stock market is at risk of a correction if this happens amid the spread of the Delta variant

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Most Wall Street strategists agree that Monday’s market rout — fueled by yawning worries about the fast-spreading COVID-19 Delta variant — should serve as a wake-up call to investors who have sent stock prices to record valuations. 

And they also generally agree on what could send stocks spiraling even lower from here — a subpar second quarter earnings season chock-full of concerning guidance due to the ongoing uncertainty of the pandemic.  

“This market is vulnerable to a bigger pullback or correction if there’s a new negative introduced, and that negative could be disappointing earnings,” warns Sevens Report Research founder Tom Essaye in a research note to clients. “If corporate earnings calls warn about (1) margins (which was hinted at by a few companies) or (2) overall economic activity (if management says activity declined in late June as COVID cases accelerated) then that will combine with the other issues (stretched valuations, complacent investors, summer doldrum trading) to cause a real pullback or a correction of 10% or more.” 

The bulls tried to mount a triumphant charge on Tuesday in a bid to quiet the bears emerging from hibernation for the first time in months. The Dow Jones Industrial Average (^DJI) rose more than 530 points in afternoon trading, paced by economically-centric names such as American Express (AXP), IBM (IBM) and Goldman Sachs (GS). 

Small-cap stocks as measured by the Russell 2000 (^RUT) also rose solidly. 

Despite the market turnaround Tuesday, angst lingers after Monday’s steep sell-off. Triggered by rising COVID-19 infections globally, investors reasoned that economies would be forced to close again due to increased infections. Or at the very least, economic recoveries from the depths of the pandemic would stall out soon as mobility restrictions are reimposed.

The Nasdaq (^IXIC) and S&P 500 (^GSPC) notched their biggest drop in nearly two months. Meanwhile, the benchmark 10-year note had its largest decline in over three months. The Dow Jones Industrial Average fell more than 900 points, marking its its worst drop since October 2020.

The Dow Jones Transportation Index (^DJT) — which tracks the performance of economically sensitive names such as FedEx (FDX)— declined deeper into correction territory (down 10% from its highs).

Even the often teflon stock known as Apple (AAPL) lost 3%.

Some of the lone winners in Monday’s drubbing were the popular 2020 stay-at-home trades — for instance, Peloton (PTON) gained 8% and Etsy (ETSY) advanced 3.5%.

“This market is vulnerable to news that could turn yesterday’s decline into something more material,” Essaye says. The strategist, however, continues to view dips in the market as buying opportunities in large part because of low interest rates and the existence of COVID-19 vaccines. 

But others on the Street are more cautious, preferring to watch the action right now rather than view market dips as attractive entry points into stocks. Their collective reason: The pandemic is far from over, and the market best realize that and quickly. 

“I am not saying we aren’t having a [economic] recovery, but what it did for me [Monday’s sell-off] was just remind me that COVID does inject an uncertainty and perhaps some unevenness, some bumps along the road. It won’t be all smooth sailing,” said Lori Calvasina, RBC’s head of U.S. equity strategy, on Yahoo Finance Live. “This is not a market that could absorb bad news.”

Monday’s market beating proves that theory out.

Brian Sozzi is an editor-at-large and anchor at Yahoo Finance. Follow Sozzi on Twitter @BrianSozzi and on LinkedIn.

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