If there’s any lesson for Wall Street in the pandemic era, it’s this: Every selloff has proved a big opportunity to buy the dip in a world of activist central banks and limitless risk appetite.
Yet the Monday rally as the omicron variant spreads will test the resolve of investors who thought they’d seen it all in the Covid roller coaster.
With fresh travel bans looming and transmission fears rife, the S&P 500 rallied more than 1% at the open after the index’s worst drop in nine months Friday. Treasuries slumped, sending yields higher, while oil jumped.
To the likes of Goldman Sachs Group Inc. and UBS Wealth Management, it all makes sense -- they reckon bad virus news has some good news for markets as the variant assuages fears of monetary tightening. But strategists at Capital Economics and Mizuho International are among those urging caution as rising cases may worsen inflation, keeping policy makers on track to cut stimulus.
The takeaway: the new variant has arrived at a drastically different point in the monetary cycle.
“I know, I know, ‘U.S. equities only go up’ etc,” wrote Peter Chatwell, head of multi-asset strategy at Mizuho. “Monetary tightening is a structural downside risk to equities, and it may coincide with weaker growth in Q1.”
While mild omicron symptoms and news of rapid vaccine reformulations are offering some relief Monday, European policy makers were already tightening rules to fight another wave of infections even before the mutation was discovered in southern Africa late last week.
The sharp risk-off session Friday, exacerbated by thin liquidity after the Thanksgiving holiday, was a sign of investors’ sensitivity to any bad headlines, with their pockets already thickly lined from the S&P 500’s 24% gain this year.
While corporations have managed to deliver a sharp profit recovery in 2021, stock valuations are elevated historically: The U.S. benchmark is trading at 21 times the next year’s earnings, compared with 18 at the end of 2019 and a decade average of close to 17.
Whether that multiple counts as stretched will largely depend on the monetary trajectory. And since omicron hit the headlines, money-market traders have pushed back expectations for global rate hikes, market-derived inflation expectations have fallen and oil has plunged.
All that is a sign markets are pricing in a drop in demand from the new variant, which may prompt central banks to slow their tightening.