Omicron is Only Part of the Story

by | November 29, 2021

For most of 2021, a common thread dominated investment thinking. Recovering global growth, underpinned by vaccination-enabled economic re-opening, and fueled by easy monetary and fiscal policies, would boost corporate earnings. In a world of negative real interest rates and unrewarding credit risk premiums, the absence of alternatives (TINA) and the fear of missing out (FOMO) would push equity markets ever higher. The doubters and Cassandras were pushed to the sidelines.

Indeed, that is exactly how things have played out this year. 

Easy money and strong corporate earnings propelled global equities higher. In the recently concluded Q3 corporate earnings season, US earnings per share rose 40% relative to year-ago levels. Three quarters of S&P500 companies reported better-than-expected profits and four fifths beat revenue estimates. Not even the Fed’s tapering announcement and some discounting of 2022 Fed rates hikes could dislodge equity bulls. 

Confidence was reflected in valuations. Year-ahead price-to-earnings index multiples recently rose to levels that exceed long-term norms by a third.

Still, there has been a nagging worry that a combination of monetary policy tightening, margin pressures, and lofty valuations would challenge or even topple the bullish equity consensus. Fortunately, the convergence of a triple threat of rate hikes, earnings disappointments and market misalignment was repeatedly nudged into the future, always at a safe distance from today’s investment decisions.

That future may now have arrived. 

The immediate catalyst is presented by the Omicron mutation of the Covid-19 variant, which threatens to unnerve consumers, workers, businesses, and governments, inducing both weaker demand and greater disruptions to supply. 

The near-term concern is that spending might stall for travel, leisure, hospitality and dining away from home—the industries hardest hit by Friday’s sell-off. But more broadly, if workers are afraid to go to their jobs, supply chains near and far could be pinched even tighter. Price spikes could hit corporate profit margins and consumer pockets. Uncertainty and sticker shock could slow broader spending, above all for big ticket items. Price surges would be transmitted quickly into broad consumer price indices. Stagflation – a scourge from the 1970’s remembered by few of today’s investors and policymakers – might result.

Those are reasons enough to fret about the economic and market implications of Omicron. But Omicron is not the only threat to investors. 

To begin, we must acknowledge that at this early juncture we simply don’t know enough about Omicron to draw firm conclusions about its potential impact on the world economy and financial markets. Early indications are that it is a highly contagious variant as reflected in its rapid spread from southern Africa to western Europe in just a matter of weeks. But it is not yet known whether Omicron also reflects a more deadly variant than its predecessors.

Still, investors are spooked. Thin holiday markets contributed to the volatile price declines in equity and commodity markets last week, as well as to the plunge in bond yields.  

But akin to medical research, market diagnosis must distinguish between symptoms and causes, no matter how difficult that may be in real time. In our view, markets were building to this moment. The ability to celebrate the present and push risk out to the future was waning before the arrival of Omicron. Rather than viewing Omicron alone as the great threat to global risk assets, it makes sense to contextualize it as exposing deeper and more fundamental market risks.

Here’s why.

Despite stellar 2021 earnings, corporate profits momentum is waning. Consensus 2022 earnings growth is a pedestrian 8%, a far cry from its torrid pace this year. Nor is that merely about the end of easy comparisons (‘base effects’) as 2022 gets underway. Sequential earnings growth from one quarter to the next has been decelerating since mid-year. On its current trajectory, quarter-on-quarter earnings growth for the S&P500 will stall, or turn negative, by the Spring of 2022. 

Higher costs for materials, energy and labor are one reason. But the sharp improvement to the bottom line driven by opportunistic recession-related cost-cutting is also over. The need to hire, build out capacity, ensure robust supplies, advertise, and re-tool distribution and sales is pushing up costs faster than revenues for the average listed company. Our proprietary models that correlate factor returns to consensus estimates of analysts confirm the same—economy-wide earnings momentum is nearing stall-speed. 

For equity markets that already command high multiples, earnings disappointments will be a big challenge. Couple that threat with worries about slower growth or higher inflation—or both in the form of stagflation —courtesy of price and wage increases that are proving more widespread, persistent, and stronger than central bankers or economists thought possible, and suddenly the market’s glidepath looks bumpy, even precarious.

Over the last year, investors have largely adopted a ‘see no evil, hear no evil’ attitude when it came to the idea that monetary policy tightening would arrive just as earnings growth flat-lined. They became seduced by faith that the future could be considered tomorrow. Transitory not only defined a gentle inflation soft-landing, but also stood for a sense of perpetual Goldilocks—a future that never impinged on the present.

Omicron is exposing the precariousness of such thinking. The future can’t be postponed any longer. It has arrived.

Filed Under: Featured

About the Authors

Larry Hatheway

Larry Hatheway has over 25 years experience as an economist and multi-asset investment professional. He is co-founder, with Alexander Friedman, of Jackson Hole Economics, LLC, which offers commentary and analysis on the global economy, policy & politics, and their broad implications for capital markets. Prior to co-founding Jackson Hole Economics, LLC Larry worked at GAM Investments from 2015-2019 as Group Chief Economist and Global Head of Investment Solutions, where he was responsible for a team of 50 investment professionals managing over $10bn in assets. While at GAM, Larry authored numerous articles on the world economy, policy-making and multi-asset investment strategy. Larry was also the lead investment manager for various mandates, funds and an actively managed multi-asset index. Larry also served on the GAM Group Management Board, was Chairman of the GAM London Limited Board and served as member of the GAM Investment Management Limited Board. Larry was also Chairman of the GAM Diversity & Inclusion Committee. During his tenure at GAM, Larry was based in London, UK and Zurich, Switzerland. From 1992 until 2015 Larry worked at UBS Investment Bank as UBS Chief Economist (2005-2015), Head of Global Asset Allocation (2001-2012), Global Head of Fixed Income and Currency Strategy (1998-2001), Chief Economist, Asia (1995-1998) and Senior International Economist (1992-1995). During his tenure at UBS, Larry was also a standing member of the UBS Wealth Management Investment Committee. While at UBS, Larry worked in Zurich, Switzerland, London, UK (various occasions), Singapore and Stamford, CT. At both GAM Investments and UBS Investment Bank Larry was widely recognized for his appearances on Bloomberg TV, CNBC, the BBC, CNN and other media outlets. He frequently published articles and opinion pieces for Bloomberg, CNBC, Project Syndicate, and The Financial Times, among others. Before joining UBS in 1992, Larry held roles at the Federal Reserve (Board of Governors), Citibank and Manufacturers Hanover Trust. Larry Hatheway holds a PhD in Economics from the University of Texas, an MA in International Studies from the Johns Hopkins University, and a BA in History and German from Whitman College. Larry is married with four grown children and a loving Cairn Terrier, and resides in Wilson, WY.

Alex Friedman

Alex Friedman is the co-founder of Jackson Hole Economics, LLC, a private research organization which provides analysis on economics, politics, the environment and finance, and develops actionable ideas for how sustainable growth can be achieved. Friedman is a senior leader with two decades of experience growing and transforming organizations in the financial and non-profit industry. He was the CEO of GAM Investments in London and chairman of the firm’s executive board. Previously, he was the Global Chief Investment Officer of UBS Wealth Management in Zurich, chairman of the UBS global investment committee, and a member of the executive board of the private bank. Before moving to UBS, Alex Friedman served as the Chief Financial Officer of the Bill & Melinda Gates Foundation. He was a member of the foundation’s management committee, oversaw strategic planning, and managed a range of the day-to-day operating functions of the world’s largest philanthropic organization. Friedman also created the foundation’s program-related investments group, the largest impact investing philanthropic fund in the world. He started his career in corporate finance at Lazard. Friedman served as a White House Fellow in the Clinton administration and as an assistant to the U.S. Secretary of Defense. He is a member of the board of directors of Franklin Resources, Inc. (Franklin Templeton), a member of the Council on Foreign Relations, Chairman of the Advisory Board of Project Syndicate and a board member of the American Alpine Club. Friedman is a regular contributor to a range of newspapers and thought leadership groups and is also the author of Babu’s Bindi, and The Big Thing, both children’s books. He is an avid mountaineer and rock climber and led the first major climb to raise money for charity through an ascent of Mt. McKinley. Friedman holds a JD from Columbia Law School, where he was a Harlan Fiske Stone Scholar, an MBA from Columbia Business School, and a BA from Princeton University.

Related Posts

Pin It on Pinterest

Share This