A Note on Omicron and Market Volatility
As I’ve often said in my weekly calls, the stock market is not driven by whether an environment is generally “good” or “bad”; instead, it’s driven by how “good” or “bad” news compares to the collective expectations.
Some unexpected bad news hit financial markets on Friday as the new Omicron COVID variant was identified in South Africa. As the U.S., Europe and other major destinations imposed travel restrictions, reopening stocks such as airlines and cruise lines sold off while safe haven assets like gold and Treasuries and stay-at-home stocks like Zoom Video Communications Inc. and Peloton Interactive Inc. traded higher.
My sense is that prior to last week’s news, most investors perceived the pandemic to be a thing of the past. In fact, according to a survey conducted by Bank of America earlier this month, global fund managers cited inflation, central bank rate hikes, and stalling Chinese growth as bigger tail risks than a COVID resurgence.
At this time, it’s unclear whether the Omicron variant will be as worrisome as the Delta variant, or worse. According to the WHO, it “has been detected at faster rates than previous surges in infection, suggesting that this variant may have a growth advantage.”
What we do know is that this news hit amid a relatively strong fundamental backdrop for stocks, supported by the following:
The U.S. economy expanded 4.9% in the third quarter ended September 2021, almost double the pace in the period before the pandemic outbreak.
Most companies’ recent earnings results and outlooks were better than expected, suggesting an ability to cope with issues like supply chain disruptions.
For the fourth quarter, S&P 500 firms are estimated to report a 19% increase in earnings, compared with flat forecast growth at the start of 2020.
We also know that the Omicron variant was labeled a "variant of concern” within days of its initial discovery, and resulted in immediate travel restrictions - a much faster global reaction when compared to the discovery and reporting of the Delta variant. When the Delta variant hit over the summer, the S&P 500 endured multiple pullbacks, and still generally continued its upward trajectory.
In my earlier calls during the first wave of the pandemic, I explored the idea of myopic risk aversion, or the tendency for investors to focus too much on the short-term and overreact to recent losses, often at the expense of long-term benefits. This concept was coined by behavioral economist Richard Thaler, and the academic paper is attached.
The markets will likely remain volatile over next two weeks, as more data on the Omicron variant is collected, including laboratory tests indicating how it interacts with existing vaccines. Nonetheless, my expectation is that stocks will remain resilient longer-term, and trade through Omicron just as they have traded through all previous Covid variants.
At Evolve Investing, nearly all of our clients have a long-term investment horizon, which provides the advantage of remaining forward-looking, and taking advantage of buying opportunities as they arise. If the market were to correct, or decline by 10% or more as a result of this news, I'd see an opportunity to add risk.
As always, please reach out if you’d like to discuss your portfolio or positioning in greater depth.
Best,
Peter Hughes, CFA