Pandemic End Game?
For the past week we have been inundated with news flow about the new Cov-SARS-2 variant of concern, B.1.1.529, or Omicron.
Having been formally identified by virologists in South Africa on 23rd November, the mutation was labelled “of concern” by the World Health Organisation (WHO) and named Omicron within days. Last Friday, the 26th November which, coincidentally, was also Black Friday, global markets sold off sharply as news of the new variant spread and governments around the world quickly introduced restrictions on travel to and from southern Africa.
Investors are concerned about the number of mutations that Omicron has, particularly relative to other variants of concern such as Delta, and what this might mean for transmissibility, vaccine efficacy, the potential for regional lockdowns and consequently the impact on the global economy. Virologists are already trying to pick apart the puzzle, but definitive answers are likely to take several weeks. In the meantime, we can expect market volatility to persist.
New regional lockdowns?
Exacerbating the mood in financial markets was news that the Netherlands and Austria introduced new restrictions on mobility in order to try and relieve pressure from stretched healthcare systems due to the globally-dominant Delta variant.
Clearly, the implementation of these travel restrictions raises the possibility of renewed regional lockdowns elsewhere. This would be a body blow to the global economy, which is just getting back on its feet. Furthermore, as the chairman of the US Federal Reserve noted, the effects of renewed lockdowns on global supply chains could have serious knock-on effects on inflation and, therefore, monetary policy.
It is too early to say how this will develop. Investors are not scientists; we try to imagine the various scenarios which may transpire from here, and how we might prepare for those. Much depends on the transmissibility of Omicron, how severe its symptoms are and how much protection current vaccines provide.
Early indications suggest that Omicron is more transmissible than Delta due to the number of mutations on the spike protein of the virus - whereby the virus invades host cells - consequently our auto immune defences and vaccines may be less effective. This is yet to be ascertained, indeed early reports from South Africa suggest that main symptoms appear to be a cough, aching muscles and extreme tiredness - somewhat milder than those experienced via Delta. If Omicron becomes the dominant variant globally, but only induces mild symptoms, this is positive, suggesting fewer hospitalisations, a gradual reduction in healthcare pressures and therefore no new lockdowns.
Where do markets go from here?
Global financial markets have been extraordinarily strong over the past 12 months and many commentators have been calling for a pull back for some time. Given high valuations and good gains made, Omicron provided a great excuse to take profits.
Having attempted a small bounce on Monday through to Tuesday morning, the US market resumed its downward trajectory after Jerome Powell said that increasing the speed at which QE is tapered (i.e. injecting less cash into the financial system each month) is appropriate and would be discussed at the next Federal Open Market Committee (FOMC) meeting.
The Fed is concerned that Omicron will delay the recovery in global supply chains as people may become less willing to work in close quarters. This would, in turn, keep inflationary pressures higher than was anticipated just a couple of weeks ago. Hence, the Fed feels that removing QE more quickly may help counter this effect.
So, if we are optimistic over the apparent lack of hospitalisations from Omicron, our outlook has not changed materially. If we avoid further lockdowns then the economic backdrop of slowing but still strong economic growth, combined with supportive (albeit becoming slowly less so) monetary policy provides a decent backdrop for equities.
However, it is still very early days in terms of news flow around Omicron and we can expect it to be the main topic of discussion in the media and markets for some time to come. This news flow will likely mean that market volatility remains elevated until we have a clearer picture over the potential impact of the new variant. Nonetheless, if the optimistic scenario above is correct, then the recent leg down is likely overdone.
What can we do in portfolios?
Well, often during these times of extreme uncertainty, the best thing to do is to do nothing. Instead, rely on sound asset allocation techniques to ensure that you are adequately diversified and ensure that you are not overly exposed to one style, i.e. value vs growth or cyclicals vs defensives. A distinct feature of the markets this year has been the regular rotation in style leadership, and one stands a very real chance of being whipsawed by the market.
Finally, I would like to apologise for an inaccuracy in my last update, where I indicated Rivian had delivered 500,000 vehicles in 2020. They have, in fact delivered far less than that and expect to have delivered 1,000 by the end of 2021.
This drastically lower number only serves to reinforce the point about fanciful valuations the market is willing to give some companies. The following chart may indicate that, after the initial meteoric rise in Rivian’s share price, investors may have come to their senses?
Until next time, stay well.