A long time to wait and a long way down.
That’s one way to think about the predicament for equities, which are still perched near record highs (and trading on nosebleed multiples in the US), in an environment of extreme uncertainty surrounding the new COVID variant.
Needless to say, the selloff on Black Friday is barely visible on a longer-term chart depicting equities’ historic, stimulus-fueled surge from the pandemic lows of March 2020. The simplest of simple figures (below) underscores the point.
Virtually never, in 100 years, have stocks managed to post the type of gains logged in the 12 months immediately following the initial COVID plunge. Or at least not in such a compressed timeframe.
A simplistic read is that with central banks poised to tighten, and the fiscal impulse set to wane, any bad news on the pandemic front that isn’t immediately met with aggressively dovish policymaker rhetoric has the potential to be destabilizing, especially given the proximity of year-end. The read-through of a steep decline in breakevens for real yields is risk-negative, and although lower Treasury yields might initially pressure the dollar, a panic would invariably bolster the greenback to the detriment of almost everything else, from stocks to gold to commodities to crypto.
For what it’s worth, stocks really haven’t de-rated this year at the index-level (figure below), although there’s been plenty of “de-frothing” (so to speak) and factor churn under the surface.
The good news is, Pfizer and Moderna seem confident they can catch up to Omicron. Pfizer said late last week the company can adapt their vaccine and ship doses within 100 days. On Sunday, Moderna’s Chief Medical Officer said the company will know whether the current vaccine protects against the new variant within “a couple of weeks” and could theoretically have a “brand new vaccine” ready early next year. “The remarkable thing about the mRNA vaccines is that we can move very fast,” he said. Moderna mobilized its staff on Thanksgiving Day. J&J is likewise testing its shot against the variant.
On Sunday, Barry Schoub, chair of South Africa’s ministerial advisory committee on COVID vaccines, told Sky News that “we can be fairly optimistic” that the vaccines will prove effective against severe disease. “The cases that have occurred so far have all been mild-to-moderate cases,” he added, calling that “a good sign.”
Meanwhile, Angelique Coetzee, chair of the South African Medical Association and the doctor credited with identifying the new variant, told BBC that symptoms have been “extremely mild” thus far.
Still, WHO cautioned it’s far too early to draw any kind of definitive conclusions. “It is not yet clear whether infection with Omicron causes more severe disease compared to infections with other variants, including Delta,” a statement said, adding that,
Preliminary data suggests that there are increasing rates of hospitalization in South Africa, but this may be due to increasing overall numbers of people becoming infected, rather than a result of specific infection with Omicron. There is currently no information to suggest that symptoms associated with Omicron are different from those from other variants… but understanding the level of severity of the Omicron variant will take days to several weeks.
And therein lies the problem for equities. “Several weeks” of uncertainty could forestall — or even ruin — a Santa Claus rally.
Still, I dare say there are more ways things can go right than horribly wrong. If the variant does turn out to be “mild” and the existing vaccines protect against severe disease, a relief rally could be just what the doctor ordered to inject stocks with a bit of fresh joie de vivre. Remember, the rally had essentially stalled after October’s rebound from the September swoon.
Additionally, assuming things don’t go totally awry, the “broad” market could lean on big-cap tech if the variant does end up causing trouble. Many secular growth high-fliers, including heavily-weighted tech titans, would once again benefit from a stay-at-home bid and also from falling yields.
However, positioning was getting a bit stretched again on the eve of Omicron. Deutsche Bank’s measure of aggregate US equity positioning was in the 88th%ile headed into Thanksgiving week, for example, essentially unchanged over the course of November (figure below).
“Discretionary positioning fell slightly, while systematic positioning increased marginally [from the] 55th to 60th%ile,” the bank’s Parag Thatte wrote, on November 19, the latest available update. “Positioning within large-caps specifically has also been steady at elevated levels,” the bank said.
Note that if sustained, the spike in realized vol (figure below) could trigger mechanical de-leveraging on a lag from the vol-control universe. “The larger risk here within systematic strategies is the volatility component, as it relates to the de-leveraging or re-leveraging of positions, because position sizing is set to be inversely proportional to the instrument’s volatility input,” Nomura’s Charlie McElligott wrote Friday.
He went on to flag the potential for local selling, noting that vol-control equity exposure was back in the 77th%ile.
But, keep in mind: One day won’t be enough to tip all the dominoes. While hedging flows and “first movers” (so to speak) can exacerbate price action during a given session depending on the setup and whether spot moves through key levels, an across-the-board mechanical de-leveraging from all systematic cohorts would require “multiple days of follow-through” via higher realized vol in order to “drag up trailing averages,” McElligott added. He called Friday “a good head start.”
On Sunday, Cyril Ramaphosa spoke in a televised address. The Omicron variant has been found in all South African provinces. “If cases continue to climb, we can expect to enter a fourth wave of infections within the next few weeks, if not sooner,” he said. South Africa is now considering making vaccines mandatory “in some instances.” The current vaccination rate, Ramaphosa remarked, is not good enough.