Weekly market update - 20th of December 2021
Written and accurate as at: Dec 20, 2021 Current Stats & Facts
COVID and inflation have been the two big issues to watch all year. Both have taken significant turns in recent weeks, leaving the outlook for 2022 as uncertain as ever. This does not necessarily mean that the outlook is necessarily negative. Rather, the potential paths we head down next year look very different:
On Covid: We could be in the early phases of the largest wave. This could put substantial strain on healthcare systems, prompting renewed restrictions which could drag on the economy and escalate supply chain problems.
Alternatively, we may discover the effects of the vaccines, anti-virals and potential lower virulence of Omicron mean the virus becomes more benign — to be handled without restrictions.
On inflation and rates: We could see economic strength and a tight labour market sustain inflationary pressures. This could prompt both the Fed and markets to realise that higher real rates are needed, prompting a sell-off in equities and growth stocks in particular.
Alternatively, we may see inflationary pressures ease as supply chains resolve themselves, people re-enter the labour force and structural factors such as tech and debt re-assert. In this scenario growth and earnings are good and we see bonds and equities rallying, with growth resuming leadership.
We should have a far better understanding of the Omicron issue within three weeks, while the rates issue will take much of next year to play out.
Markets were down last week. The S&P/ASX 300 fell 0.7% and the S&P 500 lost 1.9%.
Concerns about central bank policy and the degree to which rates need to rise to contain inflation weighed. So too did uncertainty over Covid due to contradictory research on Omicron risks and increasing government restrictions heading into Christmas.
Covid and vaccines outlook
Surging case numbers in a number of countries — notably the UK and Denmark — are fanning concerns about healthcare systems coming under strain.
The interplay between Delta and Omicron waves is complicating an assessment of the situation and government reactions. For example, The Netherlands has reimposed lockdowns despite material falls in new cases, fearing that an Omicron wave will see new cases hurtle higher again.
The risk of Omicron breakthrough infections — ie vaccinated people catching the virus — is 5.4x higher than it was for Delta, according to research from the Imperial College in London.
The key question concerns the disconnection between cases and hospitalisations.
South African data is hard to interpret because it is subject to large backward revisions. For example, the number of people in hospital with Omicron was revised up 61%. Many of these patients are in hospital for other reasons and have incidentally tested positive. This is leading some to conclude that there have been far more asymptomatic cases than first thought.
The number of new daily cases in Gauteng Province — home to more than a quarter of South Africa’s population — is falling.
This has happened within a month of the wave’s start — rather than the usual two to three months in previous waves.
There are a number of theories to explain this:
- Case numbers are being understated due to a higher proportion of asymptomatic cases
- Changes in social behaviour — people self-isolating more quickly may have a containing effect
- Better medical treatment
- A portion of the community is not susceptible to the variant
- A significant portion of the population has left the province as we approach Christmas
Each of these explanations has quite different interpretations.
The other issue is a disconnection with hospitalisations. Does this reflect lower severity or is it a function of the younger demographics in Gauteng?
A study from Imperial College — not yet peer-reviewed — claims there is no reason mutations in Omicron should lead to less severity. If there are lower case numbers it is because of vaccinations, the study says.
Nevertheless, the proportion of people needing critical care — as well as the length of hospitalisations — are materially lower than the last wave. This suggests there is some factor helping reduce the severity.
Covid in the UK and US
The UK will provide an acid test. It is too early to draw conclusions on hospitalisation rates. But we are seeing a high incidence of positive tests among British patients hospitalised for other reasons. This suggests a high rate of asymptomatic cases.
The UK will provide the lead for US, which will be the key driver of market sentiment.
US cases overall are still not rising quickly. They are up 3% week-on-week. But this was held down by declining numbers in the Midwest. Lead indicators suggest a material acceleration with the New York testing positivity rate doubling in three days.
The most effective response to Omicron is the third jab. This reloads the number of immune antibodies, materially reducing the risk of breakthrough infection.
The case growth has triggered an acceleration of boosters in most affected countries, though the capacity to administer shots at this time of year is constrained.
The key issue for markets is the policy response to this wave of cases.
The near-term risk is that markets fear the worst and governments feel the need to act, reimposing restrictions. We are already seeing this come through with US Q4 GDP forecasts moderating to 6%, down from 7-8%.
This could see a sentiment-driven sell-off in markets. But it is important to note the strength of nominal GDP growth, which means earnings should remain firm.
Economics and policy
The Fed came in at the hawkish end of the expected range, doubling the rate of Quantitative Easing tapering. QE should now end in March. The Fed’s “dot points” now indicate three hikes in 2022.
The market was initially positive because there was no escalation of inflation concerns. It is worth noting that the expected terminal value of rates did not budge, remaining at 2.1% by the end of 2024.
There are two disconnections worth noting.
First, the market does not currently believe the Fed will need to raise rates in 2023. It sees rates peaking around 1.5%, reflecting confidence in inflation fixing itself.
Second, the Fed and the market both believe inflation can be fixed without real rates ever going positive.
There is a school of thought that believes this is not credible because of key differences between this cycle and previous examples:
- Household balance sheets are far stronger
- Fiscal stimulus is far greater
- The degree of QE has been much higher
- Changes to the labour market and supply chains
- The impact of greenflation
- Real rates have been far lower for longer
There are small signs that the Fed’s pivot is already prompting inflation expectations to moderate and that we may have passed through peak fear on this front.
There are also signals that people are returning to the labour market in the US, with the participation rate edging up.
Outside the US, the Bank of England raised rates from 0.1% to 0.25%, surprising a market that expected them to hold steady given the risk from Covid. This was seen as a negative, suggesting the BOE sees inflation as a key risk.
The ECB was more balanced, announcing the end of its pandemic program of QE but putting in place a transition program. This is designed to prevent fears that early rate rises put peripheral bond markets under pressure. Inflation is less of an issue in the EU currently, which gives them more latitude.
US fiscal policy took a twist today with Senator Joe Manchin announcing he will not support the current Build Back Better package in its current form.
This likely means the current model, which was to put in programs for one, three and five year periods to reduce their apparent cost, is dead.
Rather Biden will need to reduce the programs he wants to commit to and ensure they are fully funded. This still looks likely, given Manchin’s relationship with Biden. But it will take time and will be a set-back for renewable energy-related stocks.
Markets
Overall many believe the market environment is still reasonably constructive. Growth is strong, companies have pricing power, rates remain very low and sentiment is not over-confident.
In the near term the Covid case spike could hold the market back. The early read on Omicron suggests any further sell-off would be an opportunity for bombed-out cyclicals. The medium term issue is that the market seems to be underestimating the policy response required to contain inflation.
It is also worth noting the continued rebound in iron ore. This is partly driven by inventory re-stocking, but also reflects improved sentiment on China. Beijing continues to signal a more pro-growth policy shift, albeit with no major stimulus yet announced.
Stocks
Technology stocks remain on the nose given concern over real rates, although Wisetech (WTC, +10.3%) defied this to be the best performer in the ASX 100 last week.
CSL (CSL, -8.8%) announced the acquisition of Vifor for $16.4 billion, raising about $7 billion at an 8% discount. The stock fell on the overhang of issuance, rather than a verdict on the deal.
The negative take on the acquisition is that it is diversifying into new areas in a business with some patent risk. This may say something about CSL’s view on the future of its core business.
The positive take is that this is an adjacent area, leverages some of its R&D capability and the dialysis business has good long-term growth prospects.
Historically, the company is very careful about acquisitions and has a strong track record.
Woolworths (WOW, -7.4%) surprised the market with an earnings downgrade of about 8% for FY22 and a 4-5% reduction for future years. Management cited the effect of Covid-related costs, staffing issues and the rise in online shopping.
At this point, these issues seem to be affecting WOW more than Coles or Metcash. Clearly part of this will unwind. However, labour is becoming more expensive and WOW needs to budget for more people given the disruption caused by Covid cases.
The more ominous interpretation is that the move online is entrenching a higher cost base, which the company is not yet recouping through price.
Qantas’s (QAN, -4.6%) market update outlined losses higher than the market expected due to Q3 lockdowns, but debt levels were lower. The outlook for bringing back on capacity is positive, but meaningless given the confusion over how Omicron will affect behaviour. The stock will need to bide its time as we resolve these issues, but it is priced for an extended lacklustre environment.
Afterpay (APT, -13.8%) was the worst performer in the ASX 100. It was dragged down along with most of the tech sector. There is also an increased focus on the regulation of the buy-now-pay-later sector in the US.
Finally, Charter Hall (CHC, +9.5%) was one of the week’s best performers. Valuation uplifts are helping performance fees and assets under management and driving upgrades. It is a key beneficiary of rising asset prices. The question is how it will perform if we see these begin to plateau.