The return of Covid

Expectations of earlier monetary tightening by the US Federal Reserve (Fed) and Omicron’s emergence have sparked concerns among investors. Markets concluded the month with a sell-off in risk assets, albeit more modest than the extreme moves we saw in March 2020. It will be some time before we fully understand the economic implications of the new variant and, until we do, the potential for volatility remains.

Overall, the MSCI World Index of global equities dipped -1.47% in November, while US 10-year Treasury bonds returned 0.77%.

inflation continues to soar ...

Inflation continues its rise in the UK and the US. Britain’s annual inflation rate jumped to 4.2% in October, and rose by 5.1% in the 12 months to November.

This was mostly down to higher energy costs after regulator Ofgem lifted the price cap on domestic gas and electricity bills in October. Energy prices have soared to record levels as economies around the world emerged from lockdown and Russian gas supplies failed to meet demand.

Meanwhile, the US inflation rate hit a 31-year high in October of 6.2%, up from 5.4% in September, driven by rising fuel and food costs as well as supply chain bottlenecks.

There are also inflationary pressures in the labour market, where an acute shortage of workers is forcing employers to raise wages in some sectors. While we continue to believe that inflation should start easing by mid-2022, we are closely monitoring the situation to see how it evolves.

... and prompts a fed shift

Markets were reassured by US president Joe Biden’s announcement that he has chosen Jerome Powell to continue to lead the country's central bank. He’s viewed as a safe pick – not only is he favoured by Republicans and moderate Democrats, but his accommodative monetary policy response to the pandemic has largely been credited for staving off an economic depression.

However, the recent inflation data did prompt speculation that the Fed might consider earlier monetary tightening in 2022; starting with a faster tapering of bond purchases which would then clear the way for earlier rate hikes.

OMICRON'S EMERGENCE HIGHLIGHTS THE BENEFITS OF DIVERSIFICATION

Omicron’s emergence brought back Covid fears given early signs the new variant may be more effective at escaping vaccines. Research should provide more clarity on these questions during December. Early comments from Moderna and BioNtech suggest that Omicron can evade infection protection to a greater extent, but they suspect vaccines to continue to protect from severe illness. Not surprisingly this has accelerated the vaccine booster campaigns across Europe.

Some patience is therefore required to be able to assess Omicron and its potential economic consequences. This will then shape the reaction of central banks.

Markets reacted with a swift selloff when Omicron emerged: The S&P 500 fell 2.3% and bond prices rose (and yields fell) and uncertainty is likely to continue, as Monique Wong, Executive Director, Asset Management at Coutts explains, “Following on from the market’s initial response to the emergence of Omicron, there will continue to be a period of uncertainty when the market may overreact to negative, or indeed even positive news.”

We would advise against large shifts in investments and instead highlight the benefits of portfolio diversification like bonds or defensive equities like healthcare. Here at Coutts, we have reduced European equity exposure slightly and raised some cash in portfolios as we keep a close eye on developments.

Cumulative returns calculated on sterling basis, including fees, charges and income to 30 November 2021. These data are based on composite performance, individual portfolio monthly returns are asset-weighted based on their respective asset values at the beginning of the month. Peer group returns provided by Asset Risk Consultants (ARC); end-November data represents ARC estimate. Benchmarks represent a static mix of equities and bonds in proportions relevant to each strategy. Past performance should not be taken as a guide to future performance. The value of investments, and the income from them, can go down as well as up and you may not recover the amount of your original investment. Sources: Coutts & Co, ARC. December 2021.
 

Omicron related Covid fears caused one of the largest weekly declines in our Sentiment Index. Almost all the data reflects the increased nervousness of market participants and the previous very positive mood has fallen to a neutral reading. The previous high reading of this contrarian indicator correctly signalled the increasing risk of market volatility.

OUR LONG-TERM PERFORMANCE

Return data for funds are calculated net of fees, in sterling and assumes reinvestment of dividends. Past performance should not be taken as a guide to future performance. Peer group returns provided by Asset Risk Consultants (ARC). Benchmarks represent a static mix of equities and bonds in proportions relevant to each strategy. The value of investments, and the income you get from them, can go down as well as up, and you may not recover the amount of your original investment. Source: Coutts & Co., Asset Risk Consultants (ARC), Morningstar, Refinitiv, December 2021.