Omicron’s arrival triggered a wave of risk aversion at the end of last week, underscored by a spike in volatility and sharp losses in equities and crude oil. According to the World Health Organization (WHO), omicron may be more transmissible than the delta variant and carries an unusually high number of mutations that may make it relatively more resistant to vaccines and increase reinfection risk.
Nevertheless, initial signs, based on limited data sets on vaccine efficacy and severity of health outcomes, seem promising. Public health officials in South Africa and Israel have observed that while omicron may be the most infectious variant to date, patients infected with newest variant have, so far, displayed only mild symptoms, particularly amongst the vaccinated cohort.
The emergence of another COVID-19 variant is undoubtedly a worrisome development that warrants investors’ attention, but we think a wait-and-see approach is sensible as health experts undertake the initial fact-finding phase to determine whether omicron is more infectious, lethal, or resistant to vaccines than previous variants. A number of studies underway will likely help provide insights on these concerns in the weeks ahead.
Strong arsenal available
It is important to note the substantial progress the world has made in tackling the fight against COVID-19 compared to a year ago, including: the broad availability of vaccines, an improving range of treatment options that could soon include oral antivirals (e.g., Pfizer’s Paxlovid and Merck’s Molnupiravir), and generally better preparedness of health care systems.
Vaccines, which teach the immune system what the virus looks like so our bodies can produce specific antibodies to combat that virus, arguably remain the most effective weapon against COVID-19. Vaccine makers have initiated clinical trials to determine the efficacy of their vaccines against omicron, with preliminary results expected over the next few weeks.
Encouragingly, if existing vaccines do not offer the same level of protection against serious illness, vaccine producers have indicated they should be able to tweak their vaccines to the new variant in fairly short order, with Pfizer and BioNTech, for instance, stating they “have taken actions months ago to be able to adapt the mRNA vaccine within six weeks and ship initial batches within 100 days in the event of an escape variant.” Besides, high immunization rates across major economies could still be expected to provide at least some degree of protection against omicron.
Percentage of population that has received at least one dose of COVID-19 vaccine
Source - RBC Wealth Management, Our World in Data; data through 11/30/21
A look back
Omicron is not the first COVID-19 variant that financial markets have had to wrestle with, nor will it likely to be the last. Since the onset of the pandemic, the WHO has formally designated five COVID-19 strains (alpha, beta, gamma, delta, and omicron) as a VOC, broadly defined as demonstrating an increase in transmissibility, an increase in severity of disease, or a decrease in effectiveness of public health and social measures or available diagnostics, vaccines, and therapeutics.
Global equity returns following key dates for previous COVID-19 variants
|Date||WHO label||MSCI All Country World Index: Forward price returns|
|May 1, 2020||Beta documented||7.4%||15.3%||15.1%||46.7%|
|Sep 1, 2020||Alpha documented||-3.5%||6.2%||13.9%||26.4%|
|Oct 1, 2020||Delta documented||-3.0%||13.8%||19.8%||25.4%|
|Nov 1, 2020||Gamma documented||13.4%||18.4%||27.4%||35.8%|
|Dec 18, 2020||Alpha and beta designated as variants of concern||2.5%||5.2%||10.3%||15.4%|
|Jan 11, 2021||Gamma designated as variant of concern||3.2%||5.5%||9.9%||–|
|May 11, 2021||Delta designated as variant of concern||3.0%||5.1%||7.7%||–|
Source - RBC Wealth Management, Bloomberg, World Health Organization; data through 11/30/21
Although each of the previous four variants had differing degrees of impact on the economy and, by extension, equity markets, their negative effects on markets have tended to be reasonably short-lived, albeit accompanied by unnerving volatility. Judging by the sharp whipsawing in risk sentiment this week, following last Friday’s (Nov. 26) selloff, markets look like they are behaving in a similar pattern as previous variants—a spasm in downside turbulence as investors price in short-term economic headwinds from renewed targeted lockdown/travel restrictions, followed by a growth rebound as these restrictions are gradually lifted.
Equities have been resilient through previous COVID-19 variants
Source - RBC Wealth Management, Bloomberg; data through 11/30/21
Thinking through the potential economic impact
Omicron’s economic impact depends on transmissibility, severity of disease outcomes and, importantly, the extent of vaccine evasion. But if the past is any indication of the future, the most probable outcome of this new variant will likely be a delay in the path toward full economic reopening. The upshot is that any near-term economic weakness is likely be offset by stronger growth in subsequent quarters as COVID-19 fears fade and economies resume the path of normalization.
Moreover, in a scenario where the economic impact from omicron turns out to be much worse than expected, it seems likely to us that policymakers would step in to counteract the economic fallout, with governments returning to their playbook of bolstering consumers and businesses through various fiscal spending measures and central banks keeping ultra-easy monetary policy settings in place for longer to buttress the economy.
Thus, beyond the near term, we remain constructive on the world economy on a 12-month horizon, as we see the expansion firmly supported by durable pillars of healthy household balance sheets, strong business investment, and continued support by fiscal/monetary stimulus. An expanding economy should help corporate earnings maintain an upward trend into next year, providing fundamental support for equities.
Caution warranted, but keep perspective
The discovery of the omicron variant has clearly complicated the macro outlook by introducing a greater degree of downside risks to growth in the near term; however, we would resist the temptation to jump to conclusions as more concrete information is needed to parse the variant’s potential economic implications.
Reflecting on the wide range of potential outcomes, we expect the prevailing market backdrop of heightened volatility to persist until better clarity arrives, with particular emphasis on data points pertaining to vaccine efficacy and illness severity of the novel variant. Until then, economically-sensitive assets—such as stocks and commodities—could remain vulnerable to further downside pressure as investors demand a higher risk premium to account for the elevated uncertainty.
In the interim, as we mentioned above, tremendous headway has been made in shoring up the arsenal in the COVID-19 battle. This, together with the recent history of market resilience demonstrated during previous episodes of variants of concern, suggests to us that the adverse short-term effects inflicted by the new COVID-19 variant on the economy and markets are likely to be temporary. The likely net impact of short-term speed bumps in the economic expansion due to the omicron variant is to push more growth into H2 2022 from H1.
For multi-asset portfolios, we continue to recommend a moderately Overweight stance in equities on a 12-month time frame, while making sure the fixed income portfolio is positioned with an adequate layer of “safety”—high quality bonds and cash—to counteract a larger equity weight, as well as cushion against the prospect of uncomfortable market volatility stemming from pandemic developments.