Stocks dived...

Over the past few days, Investors have watched the global markets panic, rebound, then panic afresh, as new details emerge on the Omicron coronavirus variant.

Friday last week saw US and European markets tumble as news started to flow in about the emergence of Omicron cases, first reported by South Africa to the World Health Organisation (WHO) on 24 November, 2021. While there have been other variants, this one has a large number of mutations, and appears to be highly transmissible. Omicron’s higher rate of detection compared to previous surges suggests, in the words of WHO, that it “may have a growth advantage”.

Also unsettling last week was the announcement by the Netherlands authorities that it had detected the variant in test samples a full week before the reporting by South Africa. This raised the prospect that the contagion in Europe might be more widespread than initially thought. Indeed, by the following day, Britain, Germany and Italy all said that they had detected cases, and would be imposing travel restrictions to curb its spread.

Recovered...

By Monday, the mood had lifted. There was a suggestion over the weekend that Omicron could replace Delta as the world’s dominant but less deadly Covid variant, a development deemed by markets to be a positive turn. The S&P500 proceeded to recover more than half of Friday’s 2.3 percent drop. Travel and energy stocks most punished on Friday were the biggest gainers on Monday. European markets followed suit, while Asian market falls were more limited.

Then dived again...

The optimism drained away on Tuesday following comments from Moderna CEO Stephane Bancel that existing vaccines could be less effective against the new strain. More sobering was the warning from Fed Chair, Jerome Powell, that Omicron could slow the return to in-person jobs. This in turn would slow the labour market recovery, prolong supply-chain bottlenecks and add to inflationary pressures. As a result, he suggested that inflation, already the highest in the US for three decades. would likely stay elevated well into 2022. The Fed, Powell said, was assessing whether its tapering of bond purchases would need to be accelerated.

Markets must fend for themselves

This hawkish assessment spooked an already jittery market hoping for more, not less, monetary easing to deal with the Omicron threat. But a review of developments over the past few days point to stronger market reaction than might be expected.

One possible reason for this is that having had a good 18-month run, US equities at current levels are vulnerable to a downturn, whether sparked by Omicron or something else. Another and more structural reason is the economic shift as governments and central banks enter a post-pandemic phase.

Unless Omicron forces governments to press the re-set button, which seems unlikely, most had in fact started to pull back from their broad pandemic-related support of the economy. Instead, pre-pandemic market forces are coming back into play, with banks and price-sensitive corporates once again driving economic activity.

Expect more volatility

Against this backdrop, investors can expect heightened levels of volatility over the next few weeks and months. A recovery in light of good news on the Omicron front may not be a sign that the crisis is over. Rather, it is possible that markets will react strongly to other unforeseen events, and drawdowns may be more substantial than witnessed over the past few months.

However, barring the deep restrictions seen at the start of the pandemic, this trend towards higher volatility does not necessarily spell the end of the current cycle of economic growth. Current global manufacturing, retail and jobs indicators suggest that US, European and Asian economies are emerging strongly from their respective lockdowns. And of the 486 companies in the S&P 500 that have reported earnings for Q3 2021, 80.9 percent have reported earnings above analyst estimates, compared to a long-term average of 65.8 percent, according to Refinitiv.

There also appears to be very limited appetite for fresh lockdowns amongst governments and populations. Instead, there is an increasing reliance on vaccine solutions, especially as the infrastructure is now in place. These factors lead us to conclude that there is further headroom for global equity markets, albeit accompanied by potentially bigger dips, and an Omicron-induced global recession risk remains low.