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OMICRON concerns and a pivot from US Fed chair Jerome Powell on inflation triggered a risk-off move in markets last week.
Equities fell — the S&P/ASX 300 lost 0.62% and the S&P 500 was off 1.17%. Longer-dated bond yields fell, as did the oil price. The VIX volatility index spiked above 30% for the first time since February.
In equities we saw a sell-off in more speculative tech stocks and a rotation towards more defensive value names.
The market has moved quickly to price in a great deal of fear over Omicron and the pace of rate hikes. There is a reasonable chance these concerns may be overdone – though there are still a lot of questions around Omicron.
However a combination of falling volatility, a strong rebound in the US economy supporting earnings, easing concerns over Quantitative Easing tapering, and receding uncertainty around Omicron could very well see markets rally through to January.
Covid and vaccines
The market has two current concerns around Covid.
The first is the Delta variant’s ongoing winter wave in the northern hemisphere. The second is the potential implication of the Omicron variant.
Delta wave
On the latest Delta wave, there are signs leading countries in eastern and central Europe are seeing the usual peaking of cases two-to-three months in. This is positive, suggesting that targeted restrictions can be effective.
But we are also likely to see this wave roll into other parts of the continent. Cases are rising rapidly in France and southern Europe. The UK is moving back towards the top end of its range of cases. US data is distorted by Thanksgiving, but early indicators suggest a renewed wave is building there.
So far hospitalisations remain contained in the higher-vaccinated countries.
Omicron
Omicron adds a new level of complexity to the outlook.
South Africa had extremely low case levels prior to Omicron’s emergence. A new wave had been expected, similar to what we’re seeing in Europe. But this low level of existing cases has allowed Omicron to become the dominant strain relatively easily.
The question is whether it can also become dominant in countries where Delta cases are already more prevalent.
We also don’t know whether Omicron will lead to a different pattern to Covid waves — extending them or increasing the amplitude.
We continue to wait for the data on Omicron. There are three areas to watch for:
1) Ability to bypass vaccines
Data on the difference in immune antibodies could be available within a week. It seems likely existing vaccines may be less effective at preventing infection, while still conferring some immunity. It may mean booster jabs are needed sooner than expected. Imminent data is unlikely to show the degree of protection against a severe Covid infection. Actual observations of hospitalisations will likely provide the indicator on this.
2) Transmissibility
There are suggestions from a number of scientists that Omicron has a substantially higher “R0” (rate of transmissibility) than Delta. There are a number of reasons why it may be too early to definitively conclude this. These include the low level of previous cases in South Africa, the fact that Omicron is easier to detect than Delta and heightened focus on the new variant which means testing levels are far higher. There are also suggestions it has been around for longer than a month, so we are seeing some catch up in cases reported. It may be that we need to see how Omicron spreads in a country where Delta is already prevalent to reach a conclusion.
3) Severity
We will be watching the proportion of Omicron patients that require hospitalisation and for how long. There has been speculation based on observations in South Africa that hospitalisations rates are lower than Delta. These reports say hospitalised patients are experiencing fewer respiratory issues and are able to leave hospital sooner. More data is needed.
Observations on Omicron severity are prompting speculation that Covid may be evolving into a more endemic-like virus. This might enable the world to build immunity without severe health implications and possibly signal the beginning of the end of the pandemic.
We believe it is far too early to buy into this thesis.
For one thing, cases reported so far have been in younger, healthier people who are more social and have lower vaccination rates. As cases spread into more vulnerable age cohorts we may see higher hospitalisations — so it is too early to make this call.
The upshot is that there are a lot of unknowns and potential outcomes.
The difference in reaction to Omicron and the pandemic’s beginning is notable.
In early 2020 governments and markets were slow to recognise the threat. Now we are seeing a sharp negative reaction with governments re-imposing travel restrictions and markets turning risk-off.
The risk scenarios can cut both ways here. There is a reasonable chance the outcome won’t be as bad as feared. Therefore we are mindful of not becoming overly cautious.
The US could be the key country to watch. Case numbers have been low, potentially making it easier for Omicron to establish itself as the dominate strain. Half of Americans are either unvaccinated or had their second shot more than six months ago, with fading immunity.
The final issue to keep in mind is the durability of the booster shot. We are watching Israel’s experience to see if immunity proves more durable after the booster.
Economics and policy outlook
Powell’s pivot and inflation
In his testimony to Congress, Fed Chair nominee Powell said Quantitative Easing (QE) could finish “a few months sooner” than previously indicated. He also said it was time to retire the term “transitory”. The market has moved to expecting QE to be over by end of March.
The bond yield curve flattened materially as a result. The spread between 10-year and two-year US government bonds dropped from above 100bps to about 75bps as the longer-dated yields fell.
Is it no coincidence that Powell has become more hawkish on inflation a week after his nomination for a second term as Chair.
He will need Republican votes to be confirmed by Congress — a hawkish tone on inflation helps this. Inflation is also a factor in Biden’s waning popularity and dealing with it has become a policy imperative.
We are therefore mindful of the political angle to this shift and cautious on reading too much into it.
Powell pushed rates higher in 2018 on concerns over Trump’s fiscal stimulus and almost flattened the yield curve — though he shifted quickly after equities fell sharply in response.
The great irony is that in the week “transitory” was retired, inflation expectations – reflected in the pricing of two-year forward inflation swaps — dropped materially. This partly reflects confidence that the Fed will not be complacent. Omicron concerns and some supply chain improvements are also factors.
This meant real interest rates actually rose on the week – bond yields were down, but inflation expectations were down further. This may explain the decline in tech growth stocks – particularly at the more speculative end – given the correlation with real rates.
Economic outlook
Faster tapering means reduced additional easing, not tightening. QE has not really been a driver of the Main Street economy beyond the effect on confidence of rising share prices. As a result faster tapering should not have a material impact on the economy.
However it could see rotation away from the more speculative end of markets towards more predictable and yield sensitive stocks.
It is also important to note that faster tapering does not necessarily mean rates go up sooner. The market is pricing two-to-three hikes in CY22. This may prove too many. Powell has always been very clear that the pace of tapering and rate hikes should not be connected.
Finishing QE earlier gives the Fed optionality. If the economy is slowing and inflation easing it is unlikely to go hard on hiking rates. The lesson of 2018 is to be wary of being too hawkish.
Payrolls
Payroll data was disappointing. The US economy added 210,000 new jobs in November — well below consensus expectations of 550,000.
However there are a number of offsetting factors which means this does not necessarily signal a definitive change in the labour market trajectory.
There were material, positive revisions for previous months and the latest household survey reported 1.1 million new jobs.
There were also possible early signs of workers returning to the market with the participation rate among 25-54 year olds rising 0.5%. Again, it is too soon to get too excited by this. About half the 5 million drop in workers in the last two years remains unexplained.
Headline wage growth slowed to 0.3% month on month. But underlying measures indicate it stayed at the 5-6% level, so this remains a live issue.
Markets
Concerns over tighter US monetary policy and Omicron saw de-risking in equities, exacerbated by a seasonally illiquid period in the market.
Equity market volatility, as measured by the VIX, spiked into the 99th percentile of readings. It is hard to see it moving much higher unless we see a major adverse development on Covid.
There has been a high correlation between spikes and the VIX and market corrections this year.
On this basis markets could recover into the year’s end as volatility falls. However lingering caution may see large cap and rate sensitives lead, rather than more speculative growth names.
The latter’s sell-off continues, as reflected in the relative performance of the ARK Innovation ETF as well as the BNPL, cloud, gaming and cyber security sectors versus the broader NASDAQ.
Resources are interesting — they have been tied to China growth revisions where news may be becoming slightly more positive.
In terms of sentiment we are watching credit spreads. The high yield spread over investment grade bonds has shifted up from 80bps to 130bps on recent concerns.
Oil is another indicator to watch. A combination of recent reserve releases and Omicron has seen West Texas Intermediate fall back to August’s levels — when Delta concerns peaked. If the market believes we’ll get a continuation of the global economic recovery next year we should see this bounce.
Sentiment in equity markets is softening with around 50% of stocks in the S&P 500 hitting a 20-day low. However it is not signalling capitulation.
We see scope for a recovery into January, on a combination of:
Lower volatility
Omicron concerns receding
Falling 10-year bonds
Continued strong economic environment, particularly in US
Expectations of easing policy in China
Still good liquidity
A seasonally illiquid market
Covid remains the main caveat to this view.
About Crispin Murray and Pendal Focus Australian Share Fund
Crispin Murray is Pendal’s Head of Equities. He has more than 27 years of investment experience and leads one of the largest equities teams in Australia. Crispin’s Pendal Focus Australian Share Fund has beaten the benchmark in 12 years of its 16-year history (after fees), across a range of market conditions.
Pendal is an independent, global investment management business focused on delivering superior investment returns for our clients through active management.
When rates start going up, how far will they go? It's a question Pendal's head of government bond strategies TIM HEXT has been thinking about a lot lately
WE have just released our latest Income and Fixed Interest Quarterly Report (contact a Pendal business manager for a copy) and I have spent my time recently questioning market pricing.
Right now nearly everyone is focused on the timing of RBA rate hikes versus market expectations.
The near-term performance of funds we manage is all about solving that one.
But the issue that's been occupying my mind -- and I write about in the Quarterly -- is the long-term question of the terminal rate of a hiking cycle.
In other words, when rates do start going up, how far will they go?
I think rates will move up to 1.5% in 2023. Inflation will peak around 3% in early 2023 before tapering off back to 2.5%, led by modest goods price deflation kicking in.
This will see the RBA happy to leave cash rates there for at least a year or more.
Consensus is that 1.5% cash rates will see out the rate-hike cycle. The logic is that a 2% rise in mortgage rates would hit the economy hard.
But as the decade unfolds and investment remains strong, real yields could move modestly positive once more.
That would mean cash rates closer to 2.5% than 1.5% and bond rates nearer 3% than 2%.
I doubt markets will factor this in for some time, but it's a risk to consider for long-term asset allocators.
Of course in the meantime -- with cash stuck near zero -- it is expensive to be too underweight fixed interest.
Now rates have backed up, fixed interest is once again playing its part as a defensive asset.
For those of us managing portfolios, we must play the short term while keeping in mind the medium term.
We'll leave long term to the custodians of superannuation funds whose time horizons allow for it.
Omicron is adding uncertainty to investing at the moment. Here Pendal portfolio manager Samir Mehta discusses how to approach investing in periods of doubt
Investors face weeks of uncertainty with Omicron
Barbell strategy a way of approaching investment uncertainty
How to tailor portfolio construction in such times?
It is an apt question in a week where unexpected Covid variants have roiled markets. But the important thing to remember is that uncertainty has always been a feature of investing, says Samir Mehta, who manages Pendal Asian Share Fund.
It’s not just the big unforeseen events that are difficult to predict, he says.
Mehta points to records of Treasury bond yield forecasts from the Society of Professional Forecasters — the oldest quarterly survey of macroeconomic forecasts in the United States conducted by the Federal Reserve Bank of Philadelphia.
Year in, year out for the past two decades, America’s top economists have predicted that bond yields will rise.
As you can see below from this analysis by Bianco Research, year in, year out they have been by-and-large wrong.
Bond bearishness has been a constant for decades, and horribly wrong for decades. pic.twitter.com/noSV4aN23r
“Humans by nature — especially in our industry — need to appear knowledgeable. And to appear knowledgeable you have to come across as if you know a few things,” says Mehta.
“At the moment, it seems like the rational thing to do is to consider the possibility of interest rates going up because that’s what everyone is saying.
“But there have been so many instances where we’ve been in similar positions like this, and the forecasts have been consistent for rising rates, and they just have not panned out as expected.
“There’s this big tug of war and I have no clue as to which way it will go.”
How to manage uncertainty
So, what do you do when you don’t know what will happen next?
“The question is how do you make decisions in an uncertain environment,” says Mehta.
“And that’s the job. Not just for people like myself, but so many professions involve decision making under uncertainty.”
Mehta says a simple way to construct a portfolio in uncertain times is to use a “barbell strategy” where a portfolio is weighted to opposing outcomes.
“If you do not have conviction on outcomes, you want to hedge your bets. That’s what a barbell is,” he says.
“You have enough on both sides so that you don’t get caught on the wrong end of either of them and as evidence start to accumulate, and you get more conviction, you move towards where the evidence is taking you.”
Mehta says the biggest unknown in markets remains whether inflationary pressures are transitory or here to stay.
“Let’s say the forecasters are right, that inflation is likely to be trenchant and not transient.
“That means 10-year bond yields and interest rates around the world have to rise.
“The question becomes which countries, sectors and companies are likely to be uncorrelated to the effects of rising inflation and rising interest rates?
Investing in Asia
Mehta says investors could look to Southeast Asia for this exposure.
“Southeast Asia is neglected, completely out of favour and cheap. But countries like Indonesia and even the Philippines are benefiting from the reflation due to commodities.”
And China should also be back on the list in a barbell approach.
“China is completely out of favour — but it is the one country that has acted diametrically opposite from all others from a central bank action perspective.
“The People’s Bank of China has tightened monetary policy, not allowed lending to get out of hand, the property bubble is coming under strain, GDP growth is affected.
“If the Western world goes into a rising interest rate, rising inflation environment, could we anticipate China doing the opposite? Should we be alive to the fact that liquidity conditions in China could start to become benign at a time when the rest of the world is quite negative on China?”
And what’s on the other side of the barbell?
Here, Mehta says a well-structured portfolio should own the companies that will continue to thrive should inflation prove transitory.
“I want to have some part of my portfolio in structural winners and growth in case forecasts of rising interest rates based on rising inflation turns out to be wrong.”
Samir manages Penda’s Asian Share Fund, an actively managed portfolio of Asian shares excluding Japan and Australia. Samir is a senior fund manager at UK-based J O Hambro, which is part of Pendal Group.
Pendal Asian Share Fund aims to provide a return (before fees, costs and taxes) that exceeds the MSCI AC Asia ex Japan (Standard) Index (Net Dividends) in AUD over the medium-to-long term.
Pendal is an independent, global investment management business focused on delivering superior investment returns for our clients through active management.
CHINA’S property-led economic slowdown shows no sign of ending. In this week’s The Point podcast, Pendal portfolio manager Amy Xie Patrick explains what that means for Australian investors:
An excerpt from this podcast
“The market assumes the Chinese government won't let the Chinese economy fall below 5 per cent growth. But I think the pain threshold is lower this time.
“Normally, that’s really bad news for the Australian economy. But Australia’s reliance on resource exports has gotten a lot more muted, especially with respect to China.
“For investors, it means you need to be a lot more region specific when looking at your portfolio construction, especially for a fixed income portfolio.”
What's the role of fixed income in portfolios right now? Here's a quick snapshot from Pendal's head of income strategies AMY XIE PATRICK
IT'S been a tough year for fixed income.
Fuelled by bouts of inflation tantrum, a rise in yields drove one-year total returns on most major fixed income benchmarks into the red by early November.
Only high-yield benchmarks delivered positive returns — mostly due to the recovery of credit spreads that took place at the start of the year.
Though this doesn’t help the average fixed income allocation much, since the risk-and-return profile of global junk debt is more akin to equities than fixed income.
The market currently out-hawks all central banks, pricing in a steeper path of normalisation than policy makers are willing to concede.
As you can see in the below chart, since the end of September the market has doubled its expectation around the pace of rate hikes in Australia.
That leaves a decent buffer for central banks to get “pulled-to-market” if they are wrong — and a lot of room for yields to fall if they are right.
Such a steep path of rate hike expectations leave little room for error. The latest Omicron Covid variant is a case in point.
Let’s also not forget the efficiency of markets that run ahead of hiking cycles.
From 2004 to 2006, Alan Greenspan’s Fed raised policy rates by 425bps. Over the same period, yields on US 10-year Treasuries rose a mere 33bps.
Any hiking cycle now would be hard pushed to even match half of Greenspan’s pace.
Even with inflation still rising, fixed income has an important role to play.
Its negative correlation to equity markets delivered a poor return outcome for the asset class in 2021.
But overall, portfolios have benefited from the tear that risk assets have been on.
In times of market stress that negative correlation will prove invaluable.
Compared to a year ago, 10-year government bonds in Australia now provide 85bps more yield.
There is now a fatter cushion to absorb any macro stumbling blocks lurking on the horizon.
Pendal’s head of equities Crispin Murray and his team have access to Omicron analysis from a variety of leading virologists and epidemiologists. Here are Crispin’s observations so far.
NEAR TERM, the emergence of Omicron is concerning because the sheer number of variations in the virus — notably the spike protein which the vaccines target — are very likely to render vaccines less effective in preventing the spread of the virus.
The transmissibility of Omicron is likely to be greater than previous variants, but it is still unclear to what extent.
Although the number of reported cases in South Africa has accelerated far faster than Delta, it’s unknown how long the variant was already seeded in the community or subject to super-spreading events.
The datasets are still too small to be more definitive.
We believe comments that Omicron may be less virulent — that it will lead to fewer hospitalisations — are premature.
This view is based on observations in South Africa rather than data from a trial. It can be influenced by a variety of factors such as age and the number of previous infections a patient person has had.
Mitigating this uncertainty are a number of observations:
1. Thanks to South African scientists we've identified this variant at an earlier phase than Delta. This limits the level of seeding in other countries, containing the spread and buying time for a scientific response
2. While vaccines may no longer be as effective in stopping transmissibility, there is a reasonable expectation they will continue to be effective in lessening the effects of the virus through the response of B and T cells — which play an important role in our body’s Covid defence system
3. The advent of anti-viral medicines should reduce the health consequences of those infected
4. The impact of each subsequent wave has been less material on the economy as responses become more targeted and people become more attuned to the risks
5. We are seeing accelerating economic momentum globally. This is different to what we saw when the Delta wave began to emerge in May and June.
Corporate responses to date have been along similar lines: they will wait until we have more data and a better understanding before taking any potential responses to the new variant.
What if current vaccines prove to be ineffective against Omicron?
The mRNA suppliers say they have already been working on new versions of the vaccine.
They indicate it could take 100 days to develop an Omicron vaccine -- and about six months to become available at a mass level, subject to regulatory approvals.
About Crispin Murray and Pendal Focus Australian Share Fund
Crispin Murray is Pendal’s Head of Equities. He has more than 27 years of investment experience and leads one of the largest equities teams in Australia. Crispin’s Pendal Focus Australian Share Fund has beaten the benchmark in 12 years of its 16-year history (after fees), across a range of market conditions.
Pendal is an independent, global investment management business focused on delivering superior investment returns for our clients through active management.
OMICRON concerns and a pivot from US Fed chair Jerome Powell on inflation triggered a risk-off move in markets last week.
Equities fell — the S&P/ASX 300 lost 0.62% and the S&P 500 was off 1.17%. Longer-dated bond yields fell, as did the oil price. The VIX volatility index spiked above 30% for the first time since February.
In equities we saw a sell-off in more speculative tech stocks and a rotation towards more defensive value names.
The market has moved quickly to price in a great deal of fear over Omicron and the pace of rate hikes. There is a reasonable chance these concerns may be overdone – though there are still a lot of questions around Omicron.
However a combination of falling volatility, a strong rebound in the US economy supporting earnings, easing concerns over Quantitative Easing tapering, and receding uncertainty around Omicron could very well see markets rally through to January.
Covid and vaccines
The market has two current concerns around Covid.
The first is the Delta variant’s ongoing winter wave in the northern hemisphere. The second is the potential implication of the Omicron variant.
Delta wave
On the latest Delta wave, there are signs leading countries in eastern and central Europe are seeing the usual peaking of cases two-to-three months in. This is positive, suggesting that targeted restrictions can be effective.
But we are also likely to see this wave roll into other parts of the continent. Cases are rising rapidly in France and southern Europe. The UK is moving back towards the top end of its range of cases. US data is distorted by Thanksgiving, but early indicators suggest a renewed wave is building there.
So far hospitalisations remain contained in the higher-vaccinated countries.
Omicron
Omicron adds a new level of complexity to the outlook.
South Africa had extremely low case levels prior to Omicron’s emergence. A new wave had been expected, similar to what we’re seeing in Europe. But this low level of existing cases has allowed Omicron to become the dominant strain relatively easily.
The question is whether it can also become dominant in countries where Delta cases are already more prevalent.
We also don’t know whether Omicron will lead to a different pattern to Covid waves — extending them or increasing the amplitude.
We continue to wait for the data on Omicron. There are three areas to watch for:
1) Ability to bypass vaccines
Data on the difference in immune antibodies could be available within a week. It seems likely existing vaccines may be less effective at preventing infection, while still conferring some immunity. It may mean booster jabs are needed sooner than expected. Imminent data is unlikely to show the degree of protection against a severe Covid infection. Actual observations of hospitalisations will likely provide the indicator on this.
2) Transmissibility
There are suggestions from a number of scientists that Omicron has a substantially higher “R0” (rate of transmissibility) than Delta. There are a number of reasons why it may be too early to definitively conclude this. These include the low level of previous cases in South Africa, the fact that Omicron is easier to detect than Delta and heightened focus on the new variant which means testing levels are far higher. There are also suggestions it has been around for longer than a month, so we are seeing some catch up in cases reported. It may be that we need to see how Omicron spreads in a country where Delta is already prevalent to reach a conclusion.
3) Severity
We will be watching the proportion of Omicron patients that require hospitalisation and for how long. There has been speculation based on observations in South Africa that hospitalisations rates are lower than Delta. These reports say hospitalised patients are experiencing fewer respiratory issues and are able to leave hospital sooner. More data is needed.
Observations on Omicron severity are prompting speculation that Covid may be evolving into a more endemic-like virus. This might enable the world to build immunity without severe health implications and possibly signal the beginning of the end of the pandemic.
We believe it is far too early to buy into this thesis.
For one thing, cases reported so far have been in younger, healthier people who are more social and have lower vaccination rates. As cases spread into more vulnerable age cohorts we may see higher hospitalisations — so it is too early to make this call.
The upshot is that there are a lot of unknowns and potential outcomes.
The difference in reaction to Omicron and the pandemic’s beginning is notable.
In early 2020 governments and markets were slow to recognise the threat. Now we are seeing a sharp negative reaction with governments re-imposing travel restrictions and markets turning risk-off.
The risk scenarios can cut both ways here. There is a reasonable chance the outcome won’t be as bad as feared. Therefore we are mindful of not becoming overly cautious.
The US could be the key country to watch. Case numbers have been low, potentially making it easier for Omicron to establish itself as the dominate strain. Half of Americans are either unvaccinated or had their second shot more than six months ago, with fading immunity.
The final issue to keep in mind is the durability of the booster shot. We are watching Israel’s experience to see if immunity proves more durable after the booster.
Economics and policy outlook
Powell’s pivot and inflation
In his testimony to Congress, Fed Chair nominee Powell said Quantitative Easing (QE) could finish “a few months sooner” than previously indicated. He also said it was time to retire the term “transitory”. The market has moved to expecting QE to be over by end of March.
The bond yield curve flattened materially as a result. The spread between 10-year and two-year US government bonds dropped from above 100bps to about 75bps as the longer-dated yields fell.
Is it no coincidence that Powell has become more hawkish on inflation a week after his nomination for a second term as Chair.
He will need Republican votes to be confirmed by Congress — a hawkish tone on inflation helps this. Inflation is also a factor in Biden’s waning popularity and dealing with it has become a policy imperative.
We are therefore mindful of the political angle to this shift and cautious on reading too much into it.
Powell pushed rates higher in 2018 on concerns over Trump’s fiscal stimulus and almost flattened the yield curve — though he shifted quickly after equities fell sharply in response.
The great irony is that in the week “transitory” was retired, inflation expectations – reflected in the pricing of two-year forward inflation swaps — dropped materially. This partly reflects confidence that the Fed will not be complacent. Omicron concerns and some supply chain improvements are also factors.
This meant real interest rates actually rose on the week – bond yields were down, but inflation expectations were down further. This may explain the decline in tech growth stocks – particularly at the more speculative end – given the correlation with real rates.
Economic outlook
Faster tapering means reduced additional easing, not tightening. QE has not really been a driver of the Main Street economy beyond the effect on confidence of rising share prices. As a result faster tapering should not have a material impact on the economy.
However it could see rotation away from the more speculative end of markets towards more predictable and yield sensitive stocks.
It is also important to note that faster tapering does not necessarily mean rates go up sooner. The market is pricing two-to-three hikes in CY22. This may prove too many. Powell has always been very clear that the pace of tapering and rate hikes should not be connected.
Finishing QE earlier gives the Fed optionality. If the economy is slowing and inflation easing it is unlikely to go hard on hiking rates. The lesson of 2018 is to be wary of being too hawkish.
Payrolls
Payroll data was disappointing. The US economy added 210,000 new jobs in November — well below consensus expectations of 550,000.
However there are a number of offsetting factors which means this does not necessarily signal a definitive change in the labour market trajectory.
There were material, positive revisions for previous months and the latest household survey reported 1.1 million new jobs.
There were also possible early signs of workers returning to the market with the participation rate among 25-54 year olds rising 0.5%. Again, it is too soon to get too excited by this. About half the 5 million drop in workers in the last two years remains unexplained.
Headline wage growth slowed to 0.3% month on month. But underlying measures indicate it stayed at the 5-6% level, so this remains a live issue.
Markets
Concerns over tighter US monetary policy and Omicron saw de-risking in equities, exacerbated by a seasonally illiquid period in the market.
Equity market volatility, as measured by the VIX, spiked into the 99th percentile of readings. It is hard to see it moving much higher unless we see a major adverse development on Covid.
There has been a high correlation between spikes and the VIX and market corrections this year.
On this basis markets could recover into the year’s end as volatility falls. However lingering caution may see large cap and rate sensitives lead, rather than more speculative growth names.
The latter’s sell-off continues, as reflected in the relative performance of the ARK Innovation ETF as well as the BNPL, cloud, gaming and cyber security sectors versus the broader NASDAQ.
Resources are interesting — they have been tied to China growth revisions where news may be becoming slightly more positive.
In terms of sentiment we are watching credit spreads. The high yield spread over investment grade bonds has shifted up from 80bps to 130bps on recent concerns.
Oil is another indicator to watch. A combination of recent reserve releases and Omicron has seen West Texas Intermediate fall back to August’s levels — when Delta concerns peaked. If the market believes we’ll get a continuation of the global economic recovery next year we should see this bounce.
Sentiment in equity markets is softening with around 50% of stocks in the S&P 500 hitting a 20-day low. However it is not signalling capitulation.
We see scope for a recovery into January, on a combination of:
Lower volatility
Omicron concerns receding
Falling 10-year bonds
Continued strong economic environment, particularly in US
Expectations of easing policy in China
Still good liquidity
A seasonally illiquid market
Covid remains the main caveat to this view.
About Crispin Murray and Pendal Focus Australian Share Fund
Crispin Murray is Pendal’s Head of Equities. He has more than 27 years of investment experience and leads one of the largest equities teams in Australia. Crispin’s Pendal Focus Australian Share Fund has beaten the benchmark in 12 years of its 16-year history (after fees), across a range of market conditions.
Pendal is an independent, global investment management business focused on delivering superior investment returns for our clients through active management.
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