Learning to live with Covid-19 – assessing the impact of Omicron
As 2022 begins, markets are trying to make sense of worries about the new strain of the virus and inflation.
We started to learn to live with Covid-19 last year, but the Omicron variant has clearly delivered a setback. We analyse the implications of the new strain and look ahead to the outlook for the global economy and the prospects for equities and bonds.
Let’s begin with a brief assessment of Covid. In most developed countries, cases have soared, but hospitalisation rates are typically well below their levels in previous peaks. This is partly because of the effectiveness of vaccines, partly because new cases are disproportionately hitting younger age groups, and partly because Omicron is less severe.
Hospitalisations have been much higher relative to previous peaks in some countries, including Germany, whose population suffered far less in the earlier waves and therefore has less natural immunity. This might also explain the country’s lower vaccine take-up.
Another big contrast with previous waves is the response of governments. Where restrictions have been imposed, they have been limited. But so too has been fiscal and monetary support. Even without government restrictions, people have voted with their feet and stayed away from restaurants, public transport and high streets.
So where does all this leave the global economy and financial markets? Let’s start with the good news. The finances of companies and households are in great shape as a result of previous massive monetary and fiscal support.
Much of this capital has not been spent. That’s partly due to supply shortages; as businesses have struggled in the face of disruption to transport there has been an acute shortage of semiconductors, for example. These shortages are diminishing rapidly. There is pent-up supply in many industries, notably in the automotive sector.
Companies have also been able to raise huge amounts in the capital markets. The rate of mergers and acquisitions has beaten records going back as far as 2007, before the global financial crisis.
Going into the Omicron scare, economic data in developed markets was strong. US GDP growth in the final quarter of 2021, for example, looked set to exceed an annualised 5%.
In the last two weeks, equities have been firm – up 2% in the US, UK and Europe. Emerging markets have fared less well and are down more than 2% against the MSCI index. We have previously spoken at length about the negative outlook for emerging markets and we expect this weakness to continue.
But even in developed markets, Omicron has had a negative impact. Economic data have already softened recently. In the UK and the rest of Europe, the sudden collapse in hospitality ahead of the crucial Christmas trading period means that unemployment could rise. This could end, albeit temporarily, the steady improvement that we’ve been seeing since the spring.
Fiscal policy is tightening in the UK and, with the failure of Joe Biden’s latest fiscal package, in the US too. The end of the child tax credit is likely to hurt spending in the US over the next few months.
Monetary policy is also being tightened. The US Federal Reserve is tapering its bond purchases, opening the way for an increase in the Federal Funds rate in 2022. The Bank of England has already increased base rates, albeit marginally. Even the European Central Bank has warned that its generous system of bank funding, TLTRO, will be tightened in 2022.
Against this backdrop, our favourite leading indicator for S&P500 corporate earnings, the Bloomberg profit outlook index, has dipped sharply.
All of this suggests that we are heading for choppy waters in the next few weeks. Despite this, I still favour risk assets over bonds and cash for 2022. The current struggles with Omicron in the Northern Hemisphere will dissipate as spring approaches. The world is learning to live with Covid.
Fiscal and monetary policy will be tighter but financial conditions remain extraordinarily supportive. Companies and households have plenty of cash to spend.
Expectations for earnings in 2022 have been cut back, but I still believe that they will continue grow, alongside the world economy.
While there are unlikely to be the kinds of stellar returns in the months ahead that most equity markets enjoyed in 2021, stocks should nevertheless outperform.
All that remains is for me to wish you and your families a happy, successful and safe new year. Until next week, goodbye.
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.