These are our initial thoughts on the new Covid variant:
- We don’t know enough about the B.1.1.529 variant to draw any specific conclusions at this stage. We know that it has many mutations on the protein spike, which could make current vaccines ineffective. BioNTech expects the first data from laboratory tests about how it interacts with its vaccine within two weeks. This is long enough to keep markets on edge for some time.
- What we do know, however, is that the market has a playbook for new Covid variants, having gone through the beta (first from South Africa), delta (Kent) and gamma (Brazil) variants relatively unscathed. If we follow the same path here, the initial negative reaction may prove to be temporary.
- As travel restrictions have already started to be imposed, Travel, Leisure & Hospitality sectors will remain under pressure in the immediate term, with the new variant exacerbating the worries that were already present due to the lockdowns in Europe.
- Looking further ahead, however, renewed Covid concerns also mean that the aggressive monetary policy tightening priced in by USD and GBP rates markets will probably be priced out. We held the view that the market was ahead of itself on the tightening, and this could be the moment when it starts to move towards our views (i.e. only one hike by the Fed in 2022, vs the 3 hikes that were priced before today).
- Our view that the US will outperform other equity markets in the next 3-to-6 months is being reinforced by these developments. Drawing again from the variants playbook, we know that the US is very unlikely to impose travel and other kinds of restrictions, at least not to the same degree as Europe and many EMs – especially those adopting controversial Zero-Covid policies. Growth is less at risk from B.1.1.529 in the US than elsewhere.
- Sector-wise, Tech should outperform as yields stay put or even fall, as the market has come to believe that Tech is more sensitive to changes in yields. We disagree, but that’s how the market is behaving since equity-bond correlation has turned positive. And lockdowns may have the perverse effect of slowing growth while at the same time boosting inflation, as consumers buy more stuff instead of experiences. This makes the conditions for a counter-cyclical inflation regime stickier, and this may be interpreted (wrongly, in our view) as stagflation.
- Lower yields should also be good for Utilities and Real Estate, as they have a higher beta to Treasuries than any other sectors, though Consumer Staples' is pretty high too. At the opposite end of the spectrum are Financials and Energy, which benefit from higher yields and oil prices.
- In sum, it’s difficult to say how long this risk-off phase will last, but history from previous variants suggests that it should be temporary. Ample liquidity and bullish sentiment have resulted in a strong buy-the-dip attitude by investors in recent drawdowns, and we suspect this will be the case this time too – especially if on Monday, when US trading resumes in full, the volatility we are observing today (Friday 26th November) settles down.