MARKETS rebounded as volatility subsided last week. This was due more to a lack of bad news on Covid or the US rates outlook rather than any specific good news.
The S&P ASX 300 rose 1.65% and the S&P 500 gained 3.85%. However the US rebound was not led by the sectors hit hardest in recent weeks. Energy and technology were up on the week, but less so than the overall market.
This week should provide important markers for the two main issues currently driving markets:
It is also worth noting the People’s Bank of China cut its reserve ratio requirement (RRR) last week.
This signals policy easing, though we suspect it will help stabilise recently slowing growth, rather than stimulating a new leg higher.
Covid and vaccines
Renewed waves of Delta — and potentially Omicron — mean markets are wary of the potential for lower growth into Q1 2022.
On Delta, we are seeing a sharp drop in new cases in Austria, which shows restrictions are working and demonstrates that each subsequent wave is having a lower impact.
The UK looks to be the first developed-market country seeing Omicron emerge. The government has reinstated some restrictions, fearing of the impact of a surge in cases off an already high base.
Omicron data out of South Africa has been encouraging. Case growth rate has been slowing in Gauteng province. The testing positivity rate is dropping and hospitalisations are not significantly accelerating. That said, the data can be volatile. The picture is looking more positive than a week ago, but it is still too early to draw conclusions.
Initial Omicron studies confirm the view that existing vaccines provide a lower degree of immunity. But we are yet to understand their effect on severe Covid.
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A UK study (yet to be peer reviewed) indicated a patient with two Pfizer doses had 35% immunity from Omicron 25 weeks after the shots, versus 50-60% from Delta. This rose to 75% with the booster, but it remains unclear how long that will last. Booster dose penetration will play a key part of supressing the spread of Omicron.
The risk to markets is that even a milder variant of Covid can put pressure on hospital systems through sheer weight of numbers if it breaks through vaccine protection.
The positive scenario would be that vaccines remain effective in providing immunity to severe Covid and the disconnection between cases and hospitalisations remains high.
It is still too early to make a call on which way this breaks due to the younger age profile of current Omicron clusters and the time it will take to assess data on hospitalisations.
Economics and policy
US inflation data came in slightly higher than expected. Headline CPI rose 0.8% in November versus consensus expectations of 0.7%. It is running at 6.9% year-on-year. Core inflation rose 0.5%, in line with consensus, and is running at 4.9% year-on-year.
Autos were a strong component of the rise. But even adjusting for this, inflation pressures are broadening. The rental component did not accelerate, which was a small positive.
The data should not affect the Fed decisions this week.
The key issue for the pace of tightening next year is the durability of inflation.
This will be driven by whether supply chain issues ease and by tightness in the labour market, which depends on the participation rate.
If inflation remains persistent and starts to flow through to wages, real rates will need to move higher.
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This would weigh on the valuation premiums in growth stocks. We have seen evidence of this in recent weeks in the underperformance of the more speculative growth stocks.
Property developer Evergrande effectively defaulted on public debt for the first time. We expect to see the government manage the liquidation, enabling the transfer of unfinished projects to other developers that have the resources to complete them.
Policy makers continued to signal an easing through a reserve ratio requirement cut.
The key debate for China next year is whether policy easing is aimed at accelerating growth, or to prevent a further slowdown while leaving the growth rate at a subdued level.
At this point we lean more to the latter.
The Covid-zero policy and need to manage inflation constrain Beijing’s ability to use traditional measures to promote growth.
Markets and stocks
Equity market volatility last week fell from the extreme highs of the previous week, underpinning a recovery.
But the more speculative high-growth names did not bounce back as much as the broader market.
This suggests the potential for higher real rates is weighing on these names. Larger-cap tech names have been less affected by this issue, given they are seen as higher quality.
Australian equities did not bounce back as hard as the US. Resources and energy saw a limited recovery despite the bounce back in commodity prices.
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.
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