Last week I explained why I thought equities were set to rise into year-end – the Santa Claus rally. My timing was terrible as the sudden arrival of Omicron sent markets sharply lower. Friday saw some of the biggest falls in a year or more.
So, should we forget about a Santa Claus rally and hunker down instead? Markets will obviously continue to fluctuate as news comes in. It’s very early days. There is hope that the symptoms of the new variant will be relatively mild. This isn’t just based on the remark from a South African doctor who conceded that her patients were largely fit and healthy. The nature of the mutations apparently points that way too. But that also raises fears that vaccines might prove less effective.
Governments have moved swiftly to contain the new variant
The World Health Organisation has moved Omicron straight to Variant of Concern status, skipping the intermediate Variant of Interest step. Governments have also moved swiftly too, especially in the UK, where Boris was criticised for reacting too slowly to the first wave, and in Japan, which has effectively banned foreign visitors. That owes much to the northern hemisphere winter, which creates greater pressure on hospitals and raises transmission, plus the need to ‘save Christmas’.
New cases are no longer the key variable for monitoring economic impact
Longer term, we can be reasonably confident that the world will deal with this new variant. Vaccine efficacy may be reduced but the starting levels are so high that it is likely that they will remain powerful. And they can be tweaked in few months to restore efficacy if necessary. Treatments for those that fall ill have improved enormously so that fewer new cases end up in hospital and stay for shorter periods. New cases are no longer the key variable for monitoring the economic impact of the pandemic.
Vaccines provide great protection against Covid and its variants so far. It’s the elderly that are most vulnerable of course and this chart shows what proportion remain unvaccinated. I was surprised at the high rates in Germany and France. Spain and Italy are much lower – and benefit from greater natural immunity due to their high first waves. US rates of non-vaccination are also relatively high, especially considering their data relates to the over 65s.
A potential buying opportunity, but volatility and risks have risen
Last week, global GDP was within 2% of its pre-Covid level, compared with a peak of 20% in April 2020, according to estimates by Goldman Sachs. My guess – and it is only a guess at this stage – is that the global economy will shrug off the new variant and that risk assets will recover and rise to new highs.
This suggests that we have a buying opportunity but beware, the selloff has been modest and volatility will surely remain high for a while: risks as well as potential returns have risen.
Near-term prospects for monetary tightening have changed
One thing that has definitely changed is the prospect for monetary tightening in the near term. Last week markets were pricing in a modest Bank of England base rate rise at their next meeting on 16 December. I’d be surprised if that happened. But base rates are still set to rise in the UK in 2022, if Omicron does prove to be only a minor setback, and the market pricing of 1% plus for base rates by the end of 2022 seems reasonable.
A big week for US data and speeches
It’s the US that matters most though, and we have a week of speeches by members of the rate setting committee, the Federal Open Market Committee (FOMC), before the news blackout ahead of the 15 December meeting. Pre-Omicron, and assuming the employment figures on Friday are strong, the stage would have been set for them to accelerate the pace of tapering. This would imply an earlier lift off in the Fed funds rate. I reckon that is off the agenda for now. In contrast to the UK, I think the markets are under-pricing the prospect of US rate hikes in 2022 with the Fed funds rate expected to be little more than ½% by the end of 2022. I think it will be over 1%.
All in all, I think we will still get the Santa Claus rally that I forecast last week. If I’m right, returns would be attractive, but the risks are higher too.
It’s a big week for data, and speeches by central bankers, but it’ll be Omicron that grabs the headlines. Let’s hope the news on balance will be positive.
Past performance is not a guide to future performance. The value of investments and any income derived from them can go down as well as up and investors may not get back the original amount invested.
The information, opinions, estimates or forecasts contained in this document were obtained from sources reasonably believed to be reliable and are subject to change at any time.