Global perspectives: Omicron
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The discovery of the Omicron COVID-19 variant has resulted in surging market volatility and declines in global equity markets. Omicron already appears to be highly transmissible based on preliminary data from South Africa. However, both the severity of disease and effectiveness of the current range of vaccines or prior COVID-19 infection remain open questions. The wide re-imposition of international travel restrictions is already a blow for the travel and leisure sector and the uncertainty surrounding Omicron will persist until data is released on the key parameters of morbidity and vaccine effectiveness around mid-December. We retain a cautious outlook on global equities on valuation grounds but at this stage do not see this new variant as fundamentally changing the outlook for 2022.
The advent of Omicron has however re-ignited the “lockdown trade” in the short-term as sectors such as banks, financials and energy underperformed on a global basis following the announcement of the new variant last week. We believe this reversal in sector performance is somewhat sweeping, as it implies a pause in the pace of the anticipated monetary tightening in 2022 and significant cuts in economic activity and energy demand. However, we believe developed nations are motivated to avoid the blanket lockdowns of 2020, for which there is narrowing public support as evidenced by the protests in continental Europe in recent weeks.
The re-imposition of mask-wearing mandates in England and re-energised vaccine ‘booster’ campaigns are unlikely in themselves to materially impact the trajectory of the UK economic recovery outside the travel and leisure sectors. National governments are also ill-placed to afford further strict lockdowns after the enormous fiscal costs incurred during 2020 and are in our view only likely to do so should hospital facilities risk becoming overwhelmed. In this regard, we note that both UK case rates and hospital admissions have been stable throughout the autumn, to date at least.
If the most stringent forms of lockdown can be avoided, the effect of Omicron on corporate profits may yet be modest. We note that 2022 corporate profits on a global basis have not been negatively affected by COVID-19. Rising energy and basic industry estimates have offset downgrades in the relatively smaller consumer services sector. In aggregate, current expectations for corporate profitability in 2022 remain well above levels prevailing prior to the advent of COVID-19.
Investors continue to be in a difficult spot with risk premia on global equities and credit still low yet with global bond yields already in recessionary territory. Global markets offer few safe places to preserve wealth in real terms with annual inflation currently running in the mid-single digits across continental Europe, the UK and the US.
Within an overall cautious positioning driven by the US equity market’s remarkable valuation premium even as US inflation has continued to rise, we believe investors should consider allocating to sectors which have traditionally offered better performance in periods of higher inflation. These sectors also benefit from valuation levels closer to historical norms such as banks, energy and European equities, despite the recent underperformance. Pending further data, we believe national governments’ response to Omicron is likely to be closer to that of the Delta wave with increased emphasis on mask wearing and vaccine campaigns which will have relatively little economic impact compared to 2020’s strict lockdowns.