Last week, a new coronavirus variant emerged in southern Africa with genetic mutations that could make the virus potentially more contagious than prior strains, leading to a sharp pull-back in risk assets and a fall in bond yields. There has been a spike in infections in the region, with Johannesburg’s positive testing rate rose from 1% to 30% in just one week. The new B.1.1.529 was named Omicron by the World Health Organization and is a variant of concern. These genetic changes could also potentially make vaccines or immunity from previous infection less effective.
It is important to recognize that more time, data and research are needed to understand the full impact from this mutation, including hospitalization and mortality rates. It is possible to alter mRNA vaccines to this new variant. Pfizer and Biotech said they can adapt their mRNA vaccine within six weeks and start shipping within 100 days. However, this also means the logistics of getting billions of people vaccinated will need to start again and this could take months, possibly even longer for emerging economies.
A number of governments have already announced travel restrictions with southern Africa, including the U.S., the European Union, and the UK. Sporadic cases are already appearing in Australia, Europe and the UK.
There is still much to understand about the new variant. Concerns over the possible impact on the global economic recovery has led to a sharp market correction on November 26, with the S&P 500 down 2.3%, the sharpest one-day drop since October 2020. European markets corrected more aggressively since they were already under pressure from a new wave of outbreak led by the Delta variant. Defensives, such as consumer staples and utilities, and sectors that outperformed in the early days of the pandemic were more resilient in this correction.
Safe-haven flows have pushed 10-year U.S. Treasury yield back below 1.5%, after several months of concerns over accelerating inflation and the Federal Reserve (Fed) potentially turning more hawkish. Brent crude dropped 11% with fears of a drop in energy demand if lockdowns are reintroduced.
EXHIBIT 1: DAILY INCREASE IN CASES VS. MOBILITY DATA IN THE U.S. AND EUROPE
There are some worrying signs that the Omicron variant would lead to renewed restrictions and lockdown. Investors should also observe governments’ varying approaches in dealing with new infection threats. For example, mobility data has shown that the U.S. and European economies have adopted the “live with COVID-19” approach for much of the year and hence they were able to achieve robust economic growth in 2021. In contrast, Asian governments have been more conservative in limiting cases, even though more of them are now starting to reopen as vaccination rates in Asian economies rise. Ultimately, the pressure on the medical system from any potential new outbreak would be a key consideration in which strategy governments choose to adopt.
Investors have been pricing in a smooth path to recovery for some months and the Omicron variant poses a new challenge to this constructive view. Therefore, market pressures could remain until medical experts and researchers have a better understanding of the virus. This reinforces the importance of a well-diversified portfolio and the benefits of income generation during a period when asset prices are going through heightened volatility. Short-term rotation from equities and other risk assets to safe-haven assets, such as government bonds, could continue. This would be partly driven by stemming hawkish momentum amongst developed market central banks. They could also shift their focus away from the inflation threat back to reassuring markets about their commitment to protecting growth. For example, the debate of whether the Fed should accelerate its tapering of asset purchases could be put on the backburner.
Considering governments’ experience in dealing with outbreaks and scientists’ ability to alter vaccines and medication in reaction to the new variant, the most likely scenario is a bump in the road of recovery, rather than a derailment from it. This would imply potential opportunities for long-term investors to reload on risk assets, but this would require greater clarification on the impact from the Omicron variant.