Analysis of today's markets
Álvaro Manteca, Director of Investment Strategy at BBVA Private Banking
Covid continues to condition the progress of the markets
The new variant of the B.1.1.529 virus (designated the 'Omicron' variant by the WHO) has again sowed uncertainty about the disease control prospects of the virus and its potential implications for global economic recovery. The flow of negative news with respect to the pandemic has intensified throughout the week, while expectations of more robust growth for 2022 increased, which also resulted in higher expectations for an acceleration in the Federal government's withdrawal of incentives.
On a purely macroeconomic level, the activity data learned throughout the week have been robust. In the USA, the economic indicators we are learning from October continue to show encouraging signs, with positive surprises for personal income, durable assets orders, and home sales. This suggests greater robustness, as well as increased acceleration inertia, for the economic growth prospects of the leading world power. After the somewhat disappointing GDP of the third quarter. Furthermore, the traffic jam of vessels that hope to dock in the main ports of southern California has decreased substantially during the last few weeks, suggesting that supply bottlenecks should be disappearing and no longer be a burden for production chains.
In Europe, Markit's purchasing survey data for November showed a surprise upturn, as the PMIs recovered against forecasts, both in the manufacturing and service components of the main European countries of Germany and France, as well as in the aggregate of the remaining countries. French consumer confidence also exceeded expectations, while the German IFO survey fell in accordance with the consensus's predictions. This suggests that recovery momentum has remained strong thus far, and that the concerns over the virus that weigh on many service sectors have not spread (for the time being) to the rest of the economy. It is important to note that, although manufacturing remains heavily affected by the supply bottlenecks, the shortage decreased slightly in November, in line with communications from car manufacturers. Even if evolution deteriorated in December, given the resurgence of the virus in Europe, the data we learned during the week invite optimism with regard to the growth of the fourth quarter in Europe.
As regards monetary policy, Biden's administration announced last Monday the reappointment of the current chairman of the Federal Reserve for another four years. At the same time, Governor Lael Brainard was appointed as Vice Chair. This message of continuity was accompanied by other communications during the week, which suggests that the FOMC may be gravitating toward a more aggressive stance on inflation risks. The minutes of the FOMC, written before the bullish surprise in the October CPI data, seemed to provide adjustments in the policy guidance of the US central bank's monetary policy. In this regard, the members of the Fed would not only be considering adjustments in the rate of reduction of purchasing programs when managing inflation risks, but would also potentially be considering increasing the price of money. This suggests that both decisions are intertwined, which increases the likelihood that the end of tapering will be a prelude to the first rate hikes in the USA. At the same time, communications from Governor Waller and the president of the San Francisco Fed, Mary Daly, suggest a greater probability that the pace of reduced purchases will be accelerated at the next FOMC meetings. With this, expectations of accelerated reduction in purchases and greater monetary tightening were higher during the week, until news arrived about the new variant of COVID-19.
With regard to weekend events, there is a confluence of information from multiple directions with regard to the infectious capacity and virulence of this new COVID-19 strain. The reality is that today, we do not have conclusive information from a clinical point of view, beyond the WHO warning and its classification of the strain as a "variant of concern." The president of the South African Medical Association and one of the discoverers of the omicron variant of the coronavirus, Dr. Angelique Coetzee, asked this weekend that the public not "panic unnecessarily" in the face of this new strain, whose symptoms are, according to data currently being considered,"very mild."
In short, in the coming week, investors' focus will alternate between economic data and news about "Omicron." In any case, and pending greater clarity regarding this new variant, short-term risks are undoubtedly prone to downward movement, as only in the best medical scenario would we return to where we found ourselves at the beginning of last week. There is no doubt that global stock markets have quickly adjusted risk premiums to reflect this new uncertainty factor, which gives us an interesting buying opportunity, but not without extensive volatility. During the week, news flows will alternate from one direction to another, once again putting investors' emotions to the test. It is at this point that proper emotional discipline and a highly diversified portfolio—in assets, styles, and sectors—become essential.
It is unclear to what extent the worst scenarios would trigger greater flexibility or new incentives in monetary and fiscal policies. Given how large fiscal deficits have grown (public debt increase), how large central banks' balance sheets have become, how low interest rates are, and, last but not least, how strong inflationary pressures are. Time, analysis of the new variant, and a serious deterioration of the situation will be required before policymakers will consider renewing the stimulus measures. The most obvious reaction for now would be for central banks to recognize new downward risks for growth and inflation, and to show more caution with regard to any step towards tightening monetary policy, which would once again act as a safety net in the financial markets. For the US, where no "Omicron" cases have been detected thus far, it does not substantially alter the probability that the Fed will speed up its tapering and, ultimately, could lead to a slower reduction. In Europe, where we have already had a more complicated epidemiological situation, and where the first cases of "Omicron" have been reported, the ECB could feel more validated in its cautious approach to any normalization and the need for a greater QE. It has been firm in its previous indication that the PEPP would end in March 2022, but a scenario of further deterioration of the health situation caused by the "Omicron" variant could call even\ this into question.
Meanwhile, we think that the stock markets have drained part of the high valuations and probably overreacted to this new, exogenous, perplexing market variant. In any case, we must not lose perspective, as the combination of vaccination, the ability to reprogram vaccines (if necessary), and the promising treatments that are currently being approved provide a solid fundamental argument. Despite the deterioration in the risk balance, we surmise that the fund remains favorable for risk assets, as we do not consider this new variant implies a sufficiently large change. Therefore, we do not change our recommendation to over-value equities in our portfolios, assuming that we could presumably experience sessions marked by high volatility and intense price fluctuations during the coming week.