November’s Market Commentary

Firstly, it is clear the largest systematic variable influencing the supply and demand of individual markets has been the repeat offender, Covid. Nearly all areas of the economy and the overall markets across the world are in a reactionary counter-attacking stance against the uncertainty brought by Covid.

In hindsight, the effects of Covid economically are seen to be similar to a post war economy, rather than an economic recession. Factors such as an accelerating inflation, increases in labour demand, and increases in corporate profits, bring economists to the conclusion that economies have rebounded. 

Three major events which have been of concern to investors recently are the capital inflows into the markets, the inflation and interest rate trade off, and the rise of the Omicron strain. 

2020 and 2021 Market Inflows 

During 2020 and 2021, central banks started a solid asset purchasing (quantitative easing) regimes. They purchased government and corporate bonds to stimulate the economy. By purchasing these bonds in the trillions, it was enough financial power to increase the demand of bonds, consequently causing bond prices to increase and resulting in a reduction in yields, i.e., interest rates. This stimulates the economy by allowing consumers to borrow at cheaper rates. Also, the surplus cash from the sale of corporate bonds along with reduction in yields resulted in financial institutions purchasing more equities. 

Retail investors also found themselves with more surplus cash due to the increased amount of savings. This was largely the result of government stimulus checks handed out to taxpayers. This money was partially redirected into investments and retail investors became greater market participants, which contributed to the record inflows into the markets totalling $900 billion in 2021 alone. The majority of this capital was invested into stock ETFs approx. $785billion while long-only funds saw a much smaller inflow of approx. $108 billion. A clear signal that the investors have been trying to find short term gains rather than considering a longer-term plan for investments. During this same time period, in comparison, we also saw inflows of $496 billion towards bond and fixed income funds and $260 billion towards money markets funds.  

Overall, such levels of capital inflows have pushed equity markets in the US to record highs, however, the premium that investors are paying for equities can be explained by exceptional earnings growth and free cash flow generation. 

Inflation and Interest Rates 

Accommodating monetary and fiscal policies have helped anchor economies into midcycle growth. Although individual economies are not completely synchronised, the general trend, particularly in the US, Europe, and the UK have been expansionary. However, this has come at the cost of inflation. 

Overall, inflation in developed nations has been higher than policymakers initially anticipated. Policymakers are now expecting inflation rates to be maintained at higher levels going into 2022, a change from the previously transitory stance after witnessing the recent record highs. Inflation is currently ranging between 4% to 6% across developed nations. Generally, higher inflation has come from supply and demand imbalances traced back from the pandemic. Increased energy prices, supply chain bottlenecks, and increases in labour demand, have been the main driving forces from accommodating monetary and fiscal policy. 

With the risks of higher inflation, central banks are ready to embark on an aggressive tightening cycle in an attempt to slow down inflation but with the challenge of not significantly dampening economic growth. Further reduction in asset purchases and increases in interest rates are seeming more imminent going into the new year, given the post pandemic recovery. On the other hand, central banks will be on the back foot ready to counter against any further escalations of the Omicron virus, leaving them vigilant on any inflation stabilising interventions. 

Economically sensitive assets, such as equities, are favourable during expansionary periods while investors are facing the challenge of potential volatility, all whilst attempting to outpace inflation. In terms of fixed income, though rates are low, they have risen over the past year and increases in interest rates could inch them closer to the point where bonds could provide a more competitive risk-adjusted return relative to equities.  

Covid-19 Omicron Variant  

This November, scientists made the discovery of the latest variant designated with the Greek letter Omicron. The World Health Organisation (WHO) classified the variant as a variant of concern on the 26th of November due to the initial DNA sequencing conducted upon the variant, which showcased a heavily mutated spike protein. The news of a new variant initially considered to be more transmissible and heavily mutated naturally caused panic amongst investors and was instantly reflected in financial markets. Thus, resulting in the largest single-day drop in the S&P 500 since earlier this year in February. The news of the variant has seen global travel bans implemented against most of the countries in the south of Africa amid global fears of a new wave of restrictions. 

We are ever learning more about the variant, and patience is required for scientists globally to combat three questions about the variant. These are: is the variant more transmissible, does the variant carry a greater mortality rate, and how effective are the current vaccines against the variant in both preventing spread and preventing serious illness and death. This patient approach will allow for more data to be collated and for a more concise approach to be taken in combatting the new variant. There can be little doubt that majority of the current focus is on the Omicron variant and the understanding of its implications.  

For financial markets, the timing of the variant has been significantly unsought with the existing inflationary pressures caused by the pandemic, global supply chain issues, and increased energy prices. Markets will undoubtedly be volatile and an indicator for this is the VIX which has risen by more than 50% in the last month. As seen with previous instances of new variants including the Delta variant, the markets in general carry fear and therefore begin a sharp sell-off with a strong bounce back when the full details of the variant have emerged. This is not to say the markets will react likewise when more information is obtained about the Omicron Variant.