The Investment Implications of Omicron
Financial markets tumbled last week as reports spread of a new, highly-mutated variant of Covid-19 which could be more contagious than the Delta variant and which could evade some of the immunity built up around the globe over the past year through vaccinations and infections.
It should be stressed that we don’t yet know exactly how contagious, vaccine resistant or dangerous this variant is. It should also be acknowledged that, as has been the case throughout this pandemic, the financial implications of this latest variant pale in comparison to the human suffering it has the potential to unleash.
However, for investors and those advising investors, it is important to think about the very distinct potential implications of Omicron for public health, the economy and markets.
From a public health perspective, if Omicron proves to be significantly more contagious than Delta, it could spread around the world quite quickly. For the United States, in the absence of a total and immediate ban on all people entering the country, the variant will surely hitch a ride on some inbound traveler.
The mutations contained in the Omicron variant could also reduce the partial immunity acquired from vaccines or prior infections. However, provided it doesn’t eliminate this immunity altogether, global vaccination campaigns, prior infections and better treatments could all mitigate the impact of a new pandemic wave relative to its predecessors. It is also likely that new mRNA vaccines will be developed and approved very quickly to address the variant.
However, even as we all nervously await further information on this latest variant, investors should recognize that pandemic waves should have a diminishing impact on the economy. Many people have simply mentally moved on from the pandemic and will not accept further restrictions on their activities, even with a continued public health threat, particularly for the immunocompromised or unvaccinated. Others have adapted their lifestyles to be very efficient even in pandemic conditions, conducting business over zoom, buying online and wearing masks into grocery stores. Travel and entertainment could remain somewhat depressed if a new wave emerges. However, other parts of the economy would likely see very little disruption and, as has been the case over the past two years, some spending on services could be diverted to the goods sector.
In addition, the economy should enter 2022 with a tailwind of strong wage growth, falling unemployment and huge gains in asset prices. This week’s economic reports, and particularly Friday’s jobs report, should provide further evidence that the economy is gathering momentum in the fourth quarter.
Another pandemic wave would also likely end speculation concerning an early Fed rate hike. On Tuesday, newly re-nominated Fed Chair, Jerome Powell will testify in front of the Senate Banking Committee on the oversight of the CAREs Act, which was the first major piece of coronavirus relief legislation. Chair Powell will undoubtedly take the opportunity to stress the Fed’s willingness to adjust the pace of policy normalization in light of pandemic developments. Moreover, it could be that further disruptions caused by the pandemic hurt demand more than supply, taking the edge off recently high inflation.
All told, even if Omicron causes another pandemic wave, it is more likely to slow rather than interrupt a currently rapid global economic recovery.
For the U.S. equity market, another pandemic wave could have significant consequences. In the short run, it would tend to favor those companies which fared best during the pandemic such as technology and consumer staples companies over more cyclical sectors such as energy and financials. However, markets could well look beyond the cresting of the next pandemic wave and focus instead on the very distorted valuations that have built up across financial markets and could well unwind as the economy and society finally return to normality.
More broadly, another pandemic wave, by slowing economic growth, could make it even harder for companies to maintain current extraordinarily high margins.
Last week, the Bureau of Economic Analysis reported that adjusted after-tax profits in the third quarter reached 11.0% of GDP, establishing a record high in a quarterly series which goes back to 1947. This was achieved through strong revenue growth and relatively suppressed levels of compensation, interest and tax expense. Even if another pandemic wave slows the economy in the months ahead, it would be unlikely to prevent strong increases in wages or derail a gradual increase in interest and tax expense.
It is still too early to assess the seriousness of the public health threat posed by Omicron. However, for investors, while Omicron could slow a return to normality, it is unlikely to halt it, and, rather than trying to navigate the impacts of another pandemic wave, it probably makes more sense to take a hard look at relative valuations and which areas of markets will likely fare best when we are truly and finally in a post-pandemic environment.