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US stocks set for volatility cycles as virus surges compete with vaccine news

A wave of vaccine euphoria in the U.S. stock market may soon crash into the rocky reality of record-breaking coronavirus cases and social distancing restrictions, according to several equity analysts who warned of coming volatility as markets bounce between vaccine news and the pandemic's spread.

After climbing 9.3% from the close Oct. 30 to a new all-time high Nov. 11, the S&P 500 fell about 1% on Nov. 12. This was in part due to fears that Chicago's stay-at-home advisory, which starts Nov. 16, will be the first domino to fall as cities across the U.S. impose a new round of lockdowns.

The S&P 500 settled at another new record high on Nov. 13, up 1.36% from Nov. 12, and the Dow Jones Industrial Average settled up 1.37%, also a record. But analysts were bracing for a fall.

"It is the vaccine versus spiking virus cases," said Andrew Brenner, head of international fixed income at National Alliance Capital Markets. "The jury is out, but the COVID fears in the short term are significant."

The Nov. 9 announcement of a promising investigational coronavirus vaccine from Pfizer Inc. and BioNTech SE spurred an initial rotation from pandemic plays growth stocks to reopening plays, which tend to be considered value stocks.

But that rotation fizzled as the week went on. S&P 500 value stocks, which climbed 5.35% on Nov. 9-10, fell 1.57% in the next two days. By comparison, S&P 500 growth stocks initially fell by 1.57% on Nov. 9-10 but rebounded by 0.65% the two following days.

"Traders are concerned about a long winter before the COVID-19 vaccine is widely distributed and life can return to normal," said Matt Weller, global head of research at GAIN Capital. "With other U.S. cities and regions likely considering similar pandemic restrictions in the coming weeks, we could see similar market moves soon."

The CBOE Volatility Index, which reflects expectations of fluctuations in the S&P 500, fell 38% from the close Oct. 28 to Nov. 10, but it increased about 2% from Nov. 10 to Nov. 12.

The market will likely continue to jump on positive news of vaccine developments and then fall as COVID-19 infections, hospitalizations and deaths surge, said Patrick Leary, chief market strategist and senior trader with Incapital.

"Markets are reacting to this realization that we are going to get through the pandemic, but it is probably going to get worse before it gets better," Leary said in a note. "This is why we see large risk-on moves followed by corrections."

Leary said as the damage from the pandemic rages on and more cities potentially reimpose distancing requirements, stay-at-home stocks and bonds will be "back in vogue," but the market will be rife with starts and stops and increased volatility.

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Long Treasury bond yields initially jumped on the news of a vaccine, with the 10-year Treasury yield climbing 13 basis points to 0.96% from Nov. 6 to Nov. 9, and the 30-year yield climbing 13 points to 1.73% over the same time. The 10-year yield has since sunk to 0.89% as of Nov. 13, and the 30-year yield has fallen to 1.65%.

While bracing for more damage from the pandemic, investors should also plan for a recovery, although the timing remains unclear, Leary said.

"There will be a massive unleashing of pent-up demand," he said.

Michael O'Rourke, chief market strategist with JonesTrading, said he expects equity markets to struggle into 2021 with the pandemic's effect.

"Therefore, while investors may choose to sporadically hide in the pandemic plays, they are unlikely to be nearly as aggressive as they have been," he said. "The nation is entering its darkest-before-the-dawn environment, and people should be reluctant to overpay for a flashlight."