Market Views: What are the investment implications of the Omicron variant?
Omicron, the latest Covid-19 virus variant, is stifling investor’s visibility and making it difficult to draw strong investment conclusions.
The S&P 500 closed last week recording its worst one-day percentage loss in nine months, but rebounded on Monday as hopes grew that the variant might be milder than first feared.
European markets, which were already feeling the pressure from a new outbreak of the Delta variant, corrected even more aggressively.
Most investors feel the volatility will continue in the coming weeks, but are looking for investment opportunities in the turbulence while protecting their portfolios. Sectors that outperformed during the first phase of Covid, such as technology services and healthcare, are seeing renewed investor interest, more so than the cyclical sectors.
This week, AsianInvestor asked asset managers what impact they believe the new Omicron variant will have on the markets and their investment outlook.
The following responses have been edited for brevity and clarity.
Elson Goh, head of Asia portfolio management
St. James’s Place Singapore
With the World Health Organisation highlighting the potential health risks that the new variant could bring, it remains to be seen the extent of the economic impact that could unfold, with no alignment on directives taken by policymakers yet.
We have seen certain countries such as Japan closing their borders, and this could decrease public health risk at the expense of economic recovery. On the other hand, the Omicron variant may also put some downward pressure on interest rates, which we have been hearing about for most of the year. Central banks could become a bit more cautious in times of uncertainty and this may bring about some positive reactions from the market. However, there are still future inflationary concerns.
From a portfolio perspective, it is imperative for investors to ensure that they have sufficient diversification and are not too overly dependent on leverage. Strategies looking into growth, or a value play are important as well. Over the last few years, cyclical stocks have fallen out of favour but any positive news on the efficacy of vaccines with regards to new variants could possibly lead to a stronger recovery in the market.
Tai Hui, Asia chief market strategist
JP Morgan Asset Management
Investors for some months have been pricing in a smooth path to recovery and the Omicron variant poses a new challenge to this constructive view. Therefore, market pressure could remain until medical experts and researchers have a better understanding of the virus. This reinforces the importance of a well-diversified portfolio and the benefits of income generation when asset prices are going through heightened volatility.
Short-term rotation from risk assets including equities to safe haven assets, such as government bonds, could continue. This would be partly driven by stemming hawkish momentum amongst developed market central banks. They could also shift their focus away from the inflation threat back to reassuring markets about their commitment to protecting growth. For example, the debate of whether the Federal Reserve should accelerate its tapering of asset purchases could be put on the back burner for now.
Considering governments’ experience in dealing with outbreaks and scientists’ ability to alter vaccines and medication in reaction to the new variant, the most likely scenario is a bump in the road of recovery, rather than derailing it. This would imply potential opportunities for long term investors to re-load on risk assets, but this would require greater clarification on the impact from the Omicron variant.
Ben Powell, chief investment strategist for APAC
BlackRock Investment Institute
In Asia Omicron could trigger renewed travel restrictions, growth downgrades, and worsen risk sentiment. However, if vaccines remain effective, the new strain would only delay the reopening. We don’t see this as being enough to change the otherwise solid picture for equities, which continue to benefit from the prospect of continued low real rates.
We believe equities offer higher risk-adjusted returns and a potential buffer against inflation risks – especially as we see rates rising less than in previous hiking cycles – and less than markets expect.
James Thom, senior investment director, Asian equities
It’s early days in our understanding of the Omicron variant’s transmissibility, virulence and ability to resist vaccines. We recall initial concerns that the Delta variant would weaken vaccine efficacy substantially, although in practice those effects proved very modest.
Most policy interventions have been light touch, including international travel restrictions, selective mask mandates and accelerated booster campaigns. Singapore and Australia both put off plans to admit vaccinated visitors, and Japan shut its border to non-resident travelers.
We’re monitoring events closely, but for now are not adjusting our base case for growth, inflation or policy given the high degree of uncertainty. Global alertness to coronavirus variants raises our hopes about an eventual easing of mobility restrictions and resumption of travel. As that happens we would expect Asian exports to pick up as demand grows in the US and Europe. This promises to drive consumption and corporate earnings.
That said, economists within our Research Institute acknowledge that risks to our base case have increased.
Aleksey Mironenko, global head of investment solutions
It is too early to predict how the Omicron variant will affect markets. When variants have been identified over the last 2 years, market reaction has been quick and negative as investors had limited information to process the severity of the economic risk.
Precedent shows that market consensus can change quite quickly in reaction to medical consensus, which we expect to take a few more weeks in this instance. As such, making predictions and changing portfolios based on “investor-turned-virologist” opinion does not seem prudent to us.
Knee-jerk market reaction aside, absent clear medical evidence to the contrary, we do not see any change to our investment thesis of the global economy being on sound footing, rates trending up and cyclical equity names being supported going forward.”
Jack Janasiewicz, portfolio manager and lead portfolio strategist
Natixis Investment Managers Solutions
Shoot first. Ask questions later. The market has been itching for a reason to sell off and it finally got one in the Omicron variant. But how should the market be thinking about this? We need to answer the following questions to get a better understanding of market implications: How contagious is the variant? How virulent is it? And how proficient are existing vaccines in fighting it? It will take some time before we get the answers to these uncertainties which only adds to volatility and de-risking in markets.
Government response in the meantime will drive market sentiment. The US has been loath to re-engage draconian restrictions while Europe has hinted at various forms of lockdowns and China still targeting a zero-tolerance strategy. The more open and mobile the society, the less economic damage. And with the knee jerk reaction to impose travel restrictions across the globe, it is not surprising that travel and leisure stocks are taking a hit along with oil prices.
Longer term, should Omicron prove to be more serious, labor market concerns and supply chain disruptions could intensify as people's willingness to work in person could once again begin to weigh on markets. Plenty of questions with limited answers so far. And it is not surprising that we see a 'sell first ask questions later' response by investors.
Brian Nick, chief investment strategist
After a long period in which markets were focused on “upside” risks – e.g., inflation and rising interest rates – news of the Omicron variant of COVID-19 has caused investors to refocus on downside risks to both economic activity and financial market performance in 2022. The impact thus far has been chiefly felt through measures like implied volatility (VIX) and the equity risk premium (equity valuations down, bond yields down), both of which traditionally occur during periods of elevated uncertainty about the virus or the policy response to it.
The virus itself does not have a large economic impact, but fear of the virus, exhibited through mitigation policies (i.e., lockdowns) or diminished consumer spending or employment growth, can have a large effect as we saw during the Delta variant wave over the summer. Markets have to this point been able to look past the immediate impact of the virus and through to the eventual recovery. In addition, the economic impact of each wave of COVID-19 has been smaller than the one before it, as consumer adapt and governments narrow their range of mitigation measures to what is a) effective; and b) politically viable. One of the largest economic impacts in 2020 came from school closures, which seem very unlikely to resume in any but the worst case scenario for Omicron.
Alexandre Tavazzi, global strategist, head of CIO Office & CIO Asia
Pictet Wealth Management
Our 2022 scenario assumes Omicron would not derail economic recovery in 2022. We will stick to our scenario if Omicron turns out to spread rapidly but cause only mild symptoms, saving ICU units. This case would require a well-diversified portfolio that includes companies that have pricing power, beneficiaries of economic recovery, and capital spending plans. Equities should do reasonably well, as we expect around 8% of total return from global equity markets in 2022.
If its effects are more serious, then a more defensive stance must be taken as growth will suffer in 2022, particularly for service sectors. WFH will be again favored, as governments and central banks come to the rescue of private corporations again. Recovery will be at risk and growth companies will be the winners in the equity market, as this segment contains large tech companies that benefit from digital consumption. The expected Fed interest rates hikes would potentially be at risk, and equity markets would correct.
Ben Luk, senior multi asset strategist
State Street Global Markets
While it’s still too early to determine the impact of the Omicron variant, we believe it often comes down to two scenario, which is either “bad news is good news” or “bad news is bad news,” and we are leaning towards the latter scenario given our investor behavior model recently moving from pro-risk to risk-neutral.
The optimistic outlook for risk (i.e. bad news become good news) in terms of the new variant is the drag on re-opening and consumption, which could spillover to a looser Fed, a weaker dollar and subsequent delay in tapering, rate hikes or both.However, we are increasingly concerned over persistent inflation as eight out of the ten factors that we track indicate prices trending higher on the back of seasonality trends, supply side pressure, media intensity and last but not least, wage pressures. This creates additional challenge for the Fed to reverse course and be more accommodative even if the new variant is deemed more dangerous (i.e. bad news is bad news) especially when we compared how aggressive monetary policies were globally during the delta variant period.
This is not to say we should immediately tilt towards going defensive, but with real money already well positioning into risk, especially reflation assets such as equities and commodities, over the last twelve months coupled with aggregate cash levels moving back towards long-term average, we believe an overall risk-neutral approach would be more suitable irrespective of how the new variant will play out in the coming weeks.