Financial markets have spent the last eighteen months looking over their shoulder for new and potentially more dangerous Covid variants. The arrival of the more transmissible Omicron in late November initially looked like it may herald what many had feared. Governments responded by putting in place restrictions and activity sagged. Yet despite soaring infection rates and a pick-up in hospitalisations, deaths have remained low. Investors interpreted this as the ‘market clearing event’ that facilitates the transition to a more normalised environment. Equity markets rebounded and made new all-time highs.
The minutes of the December Federal Reserve Board showed participants believed that higher inflation and a tight labour market could necessitate lifting short-term rates “sooner or at a faster pace than participants had earlier anticipated.” Officials also now expect to end the expansion of the Fed’s balance sheet in March. The practical impact of these moves is limited but the ‘signalling’ effect is more significant and has driven a sharp rotation out of ‘growth’ stocks into ‘value’. Despite the initial intra market volatility, monetary conditions are not about to dramatically tighten. Investors will, however, need to navigate the transition from a liquidity driven bull market to one driven by earnings. Volatility has increased and the recent sector rotation will likely continue. But with a strong underlying global economy and significantly negative real interest rates the equity bull market is intact.
The emerging consensus that Omicron, while more transmissible, is considerably less virulent positively impacted numerous sectors. Increased confidence in the economic outlook drove a recovery in cyclicals. Travel related stocks bounced strongly as confidence grew that the worst of any Covid disruption was behind us. We believe a more regular market is already factored into market expectations but unfortunately this will only become apparent with time. Even if conditions prove to be weaker than anticipated the company is more diversified than it has been in the past and the valuation attractive.