by Franklin J. Parker, CFA
- Top of mind for investors this week is the omicron Covid variant that popped up toward the end of last week as a serious concern. There is a lot to unpack here, so I will address this in “The Details” below.
- What is of longer-term concern is the likelihood of the Fed ending quantitative easing and raising rates at a faster pace than previously anticipated (this was discussed last week). Originally, investors had planned an end to QE in June 2022 with rate hikes to begin in the six months following. It now seems equally likely that tapering will be completed in spring of 2022 with rate hikes to follow the rest of the year. This could change if omicron is more impactful than I currently expect.
- November jobs post on Friday, a key input in the Federal Reserve policymaking. Current expectations are a headline rate of 4.5%, however the participation rate will also be key as people have been leaving the workforce in significant numbers lately. A significant portion of the recent decline in the headline unemployment rate has been workers ending their search for work (and thus no longer being counted in the labor force).
- I am watching two other pieces of news closely, neither of which are getting much attention in the financial press. The first is the debt ceiling debate. Congress has until December 15 to raise the debt ceiling, and if history is any guide this will come down to the wire. While a small probability, there is always a concern that the negotiations will falter and the US Treasury will be unable to pay interest payments on treasury bonds—financial Armageddon.
The second is the buildup of tensions between Russia and the Ukraine. Russia has amassed around 90,000 troops on the Ukrainian border, and the Ukrainian president has alleged that Russia had planned a coup to topple the government in Kiev. While not worth significant worry just yet, both news items should be watched closely.
Omicron is top of mind for investors this week, especially after Friday’s strong selloff. Even though it was only a half-day of trading, volume was on par with the previous few days. Clearly this has spooked investors.
Obviously there is concern about more lockdowns, supply constraints, and lost economic activity. Of course, not nearly enough is yet known to make an assessment of how damaging it could be. My inclination is to expect that it is not particularly noteworthy (Delta also carried the same fear and that fear fizzled), though there are some mutations in this strain that make it more concerning, at least in theory. At the moment, the raw number of cases is not all that concerning, but it is climbing quickly and some 80% of Covid treatments in South Africa are currently the omicron variant.
There are numerous second-order effects that must be considered. The Fed is the first and most obvious. Any sign of Covid-induced economic slowdown is likely to draw a response from central banks around the world. Indeed, investors quickly repriced bonds as well as rate-hike expectations on Friday, showing a move to 2 rate hike expectations for 2022 (rather than the 3 previously). The Fed, in my view, is not likely to respond until any effects are visible in the economic data (unemployment, GDP growth, etc).
Market reactions were very knee-jerk and, in my view, not particularly nuanced. Friday was a “sell first ask questions later” response. In addition to the Fed likely offsetting any significant pain from Covid-induced disruptions, I also do not see the political will (in the US) for 2020-style largescale lockdowns. That isn’t to say there would be no disruption, of course. Rather, I am pointing out that investors should have little worry for a 2020-style market selloff because the Fed is in play and lockdowns are considerably less likely. If the chart above communicates anything, it is that these Covid waves are disruptive, but not catastrophic.
In the end, I sense that the market downswing from Friday is likely not done, but that it is likely to be short-lived, and not as dramatic as March 2020. Investors can and should use it as an entry point for cash, and otherwise pay it little mind. Of course, further developments may well change my view.
Chart of the Week
A look at new Covid cases versus the S&P 500 shows a rough relationship between rising cases and poor S&P 500 performance. What we find, though, is that markets tend to price the new wave well ahead of the peak. I would expect similar behavior this time around. If omicron is to become a new wave of cases, markets will price that in advance of the worst, and begin their recovery just as the peak is occurring.
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