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Equity Strategy 2022: Here We Go Again

Feature Stories | Dec 02 2021

The emergence of omicron has sent markets and government into a potentially overwrought panic, but until we know more about the new variant the outlook is clouded.

-Global economic outlook was solid ahead of omicron
-Transmissibility and vaccine effectiveness as yet unknown
-Until then, economists remain more optimistic than pessimistic
-Australia relatively well-placed

By Greg Peel

In FNArena’s last update on equity strategy, Into The Headwinds (link below), the consensus among economists and analysts was that economies would continue to grow in 2022 but at a slower pace than in 2021. High inflation would last for longer than first thought but would start to ease at least by the latter half of the year.

Delta would ease as vaccinations rates continued to grow. Government fiscal stimulus, of the direct hand-out variety, would cease and central banks would shift into policy tightening through rate hikes – some sooner, some later. Corporate earnings growth rates would slow, but the outlook for equities would remain positive overall.

One caveat to the above was, of course, unless another new deadly strain of covid appeared.

Delta not done with

Before the sudden announcement of a new variant last Friday, and the swiftest time yet for WHO to officially declare it a “virus of concern”, the expectation of delta risk easing was already being tested as the northern hemisphere moves towards winter.

Before omicron, Europe was entering its fourth covid wave. The case-count in Germany has reached to a level 217% higher than the prior January peak as the more infectious delta muscled out prior strains.

Even in the Netherlands, where the percentage of fully vaccinated exceeds the European average, the case-count has surged and partial lockdowns have been instigated.

The good news is German hospitalisations are only running at 40% of the prior peak, notes Wilsons Stockbroking. Of those European countries seeing higher case-counts than the prior peak, hospitalisations average 35%. Of those where the case-count is lower, hospitalisations are only 19%.

Hospitalisation numbers are what really count in terms of economic impact rather than case numbers per se. While delta has brought about yet more deaths, incidences of mild symptoms or asymptomatic cases have been greater.

The UK has been an interesting case study, Wilsons suggests, as while the country has been dealing with elevated case numbers for some time, hospitalisations are only 22% of the prior January peak and the death rate 12%.

The US is also experiencing a rise in case numbers once more but for financial markets, inflation and monetary policy have been the far more influential focal points.

Australia is in better relative shape, Wilsons declares, given a higher vaccination rate than Europe or the US, a booster program now underway and the fact we’re heading into summer, not winter.

But Wilsons was writing before omicron.

Variant of Concern

Omicron is the fifth covid variant officially classified as a “variant of concern” by WHO. Following on from the original Wuhan strain, we saw alpha appearing in the UK, beta in South Africa and gamma in South America. Delta emerged out of India and overrode all previous strains.

Delta proved to be more infectious. Given the pace of spread of omicron in just a matter of days, the fear is omicron is more so.

Omicron was actually first detected in Botswana on November 9. It was not until November 24 the South Africans confirmed it was a new strain and alerted WHO. Two days later WHO named it a variant of concern, much faster than any earlier variant.

Omicron has spread faster across southern Africa than delta and the percentage of omicron in case-counts is rising exponentially. At the time of writing, omicron has been detected in 20 countries including Australia and the US.

This suggests omicron is more infectious than delta, and will push delta aside.

The question is as to whether omicron is more virulent, leading to an increase in hospitalisation/death rates. Evidence from South Africa is it is infecting younger, rather than older, people and symptoms are milder than delta. Both cases reported in NSW to date have been asymptomatic, and young.

As older people are more vulnerable, this could be good news, except that South Africa has a very young average age compared to Western countries. So the jury’s still out.

We will have to wait at least two weeks if not longer to ascertain whether current vaccines are equally effective against omicron, less effective or not effective. If a new vaccine is required, it is not expected to be ready before February, and the world will need to go back into months-long rollouts.

It is nevertheless believed that antiviral treatments, which lesson the symptoms of covid and thus hospitalisation/death risk, such as those produced by Merck and Pfizer, will be effective. Furthermore, existing covid testing is successfully detecting omicron.

Ord Minnett points out that in Australia’s case, action to close the border to southern Africa and for states to shut borders again has been much swifter this time around than the delta response. The same is true in many countries.

But while not enough is yet known, renewed lockdowns cannot be ruled out. It will be a tough call for premiers already facing restriction backlashes and having already paid the economic price of prior lockdowns. “Living with covid” remains the current mantra, based on 90% vaccination rates, but living with omicron might be a whole new decision.

Central banks have, since covid arrived, ensured they would step in with further supportive policy measures if required, which makes Fed chair Jerome Powell’s talk this week about speeding up tapering all the more untimely.

The Impact

“Understanding transmissibility is the biggest factor in determining the level of concern for omicron,” suggests Morgan Stanley. “If it outcompetes delta, than the level of concern should be very high. If it does not, omicron will create limited disruption”.

The broker’s new “base case” is now one of a variant that rapidly replaces delta, increases infection rates and reduces vaccine effectiveness. However, there is a modest, but real, possibility the outcome is less severe.

To that end, Morgan Stanley suggests, for now, omicron is expected to have a limited impact on the broker’s global growth forecasts.

They are that global growth will remain above-trend, inflation is mostly transitory and central banks will raise rates at a much slower pace than the market is currently pricing (writing before the Fed upped the ante).

The broker notes four main influences on inflation of which three will prove transitory in its view.

Current wage inflation has been driven by people choosing not to work due to government handouts. With these ending, and lockdowns ending, Morgan Stanley expects individuals to return to the workforce and the pressure to fill employment positions will ease, thus easing wage inflation.

The same payments have also sparked a rush to buy goods. For example, since April 2020, furniture prices in the US have risen 30% and used car prices 40%. With mobility returning to society, households are shifting their consumption back to services, Morgan Stanley notes, including movies, restaurant meals and other general “experiences” they had been locked out of.

This shift should alleviate pressure on supply chains and the inflation they are driving.

Commodity prices have risen sharply since last year’s recession as supply has been unable to keep up. Morgan Stanley believes most commodities will likely move back into oversupply in 2022, leading to price falls and lower inflation. The exception is iron ore, which the broker believes has likely bottomed.

The other exception, and the exception to inflation being “transitory”, is energy prices. The energy sector is now positioning for a net-zero future, and spending serious money to do so. These funds are being diverted away from investment in fossil fuels, long before fossil fuel demand subsides. In short, the world is simply not ready yet.

Morgan Stanley cites the example of the world’s “greenest” country in terms of electric vehicle take-up. EV demand in Norway now accounts for 70% of new car sales, yet demand for petrol and diesel has remained flat for the past five years.

Amidst all the hype currently surrounding EVs, especially on stock markets, there is never any mention of the obvious: no one has yet proposed an electric airliner, or cargo ship.

Morgan Stanley believes oil supply will peak ahead of oil demand, putting upward pressure on prices, i.e. inflation.

But the broker also points out that inflation measures such as CPI are “rate of change” measures. Hence while a 40% jump in US used car prices has had a big impact on current inflation, for that inflation rate to be maintained used car prices will have to jump another 40%. Even if they only flatten at high levels, the ongoing inflation rate impact is zero.

Hence inflation is transitory, and hence Morgan Stanley believes central banks will raise rates at a slower pace than markets are currently predicting.

Thus the global economy will continue to grow at an above-trend pace for the foreseeable future. Business investment in the US, the broker notes, and in the larger emerging markets of Brazil, Russia and India, has led to the fastest cyclical recovery since the War, with a focus on manufacturing machinery and IT equipment and software.

Despite government handouts ending, consumer savings rates in developed economies remain significantly excessive, supporting ongoing robust consumption.

And the US is not the only country planning to spend up big on infrastructure.

Of course, all of the above is predicated on omicron transmissibility, which if proven more transmissible than delta could lead to further lockdowns in Asia, Morgan Stanley notes – the world’s manufacturing hub.

While China is trigger happy when it comes to lockdowns, Taiwan is also sticking to a zero-covid policy and it is the world’s leading producer of the computer chips used these days in just about everything. Chip shortages have been the biggest factor in the general supply shortages that have been driving inflation.

Feelin’ Alright

If economists and analysts agree on anything, which is rare, they all agree that when it comes to omicron “we just don’t know yet”.

They also agree Australia is doing rather well in the context.

Despite gravest fears, the Australian economy’s swift rebound out of the original 2020 lockdowns caught all and sundry by surprise. Hence economists and analysts were sanguine about this year’s delta lockdowns, and again, up till now anyway, the rebound has been swift.

Australia has one of the world’s highest vaccination rates, assuming that helps, and one of the world’s lowest delta case-rates.

The federal government had planned to reopen the international border to foreign students and skilled migrants from December 1. Morgan Stanley notes that before covid, net migration contributed about half of Australia’s long term economic trend growth.

That date has now been pushed out two weeks due to omicron. So again, we can only wait.

Another positive for Australia, and for the global economy, is that Beijing’s economic policies are now shifting back to supportive rather than restrictive, as the government weighs up the fallout from environmental restrictions, power shortages, shut-down production and a potential property market collapse.

China was posing the global economy’s biggest threat as it was forced to slow down, but monetary injections and policy shift should reduce that threat in 2022.


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