Investors Were Delaying a Reckoning. With Omicron, It Has Arrived.

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dream time

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About the Author: Larry Hathaway And alex friedman Jackson is the co-founder of Hole Economics and the former chief economist and chief investment officer, respectively, of UBS.

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For most of 2021, a common thread dominated investment thinking. Corporate earnings will be boosted by a vaccine-enabled economic reopening and recovering global growth driven by easier monetary and fiscal policies. In a world of negative real interest rates and credit risk premiums, the absence of options (TINA) and the fear of missing out (FOMO) will propel equity markets higher. The skeptics and Cassandra were put to the side.

Actually, this year things have happened exactly the same way.

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Easy money and strong corporate earnings propelled global equities higher. In the recently ended third-quarter corporate earnings session, US earnings per share rose 40% against a year-ago level. Of the S&P 500 companies, three quarters posted better-than-expected profits and four-fifths beat revenue estimates. Even equity bulls may not be displaced by the Fed’s tapering announcement and some relaxation in 2022 Fed rates.

There was confidence in the assessment. The year-ahead price-to-earnings index multiplier recently reached a level that exceeds the long-term benchmark by a third.

Still, there are concerns that a combination of monetary policy tightening, margin pressure and high valuations will rapidly challenge or even undermine equity consensus. Fortunately, the convergence of the triple threat of rate hikes, earnings gloom, and market misalignment was kept at a safe distance from the investment decisions of today, again and again in the future.

Maybe that future has come now.

The immediate catalyst is presented by Omicron’s version of COVID-19, which threatens to cripple consumers, workers, businesses and governments, leading to both weaker demand and greater disruption in supply.

The near-term concern is that spending for travel, leisure, hospitality and dining away from home could stall – the industries worst hit by Friday’s sell-off. But broadly speaking, if workers are afraid to go to their jobs, supply chains near and far could be tightened even further. A hike in prices may impact corporate profit margins and consumer pockets. Uncertainty and sticker shock could slow broader spending, most notably for big-ticket items. Price increases will be quickly transmitted to the broader consumer price indices. Stagflation—a crisis of the 1970s remembered by some investors and policymakers today—could be the result.

Those reasons are reason enough to be concerned about Omicron’s economic and market implications, but this latest mutation is only part of the story.

To begin, we must acknowledge that at this early juncture we do not know enough about Omicron to draw firm conclusions about its potential impact on the world economy and financial markets. There are early indications that it is a highly contagious form as it spread rapidly from southern Africa to western Europe in a matter of weeks. But it is not yet known whether Omicron also shows a more lethal form than its predecessors.

Yet investors are scared. Thin holiday markets contributed to the decline in bond yields, along with volatility in prices in equity and commodity markets last week.

But similar to medical research, market diagnostics must distinguish between symptoms and causes, no matter how difficult it may be, in real time. In our view, the markets were building up by this time. Before Omicron’s arrival, the ability to celebrate the present and push risk into the future was diminishing. Rather than viewing Omicron as a major threat to global risk assets alone, it makes sense to refer to it as highlighting deeper and more fundamental market risks.

Why here?

Despite the great 2021 earnings, the corporate-profits momentum is slowing down. The consensus is 2022 earnings growth is a pedestrian 8%, a far cry from this year’s brisk pace. Nor is it simply about the end of the easy comparison (“base effect”) as 2022 gets underway. Sequential earnings growth from one quarter to the next is slowing down mid-year. On its current trajectory, quarter-over-quarter earnings growth for the S&P 500 will stall, or turn negative, by the spring of 2022.

One reason is the high cost of materials, energy and labor. But the sharp correction to the bottom line, driven by cost-cutting related to the opportunistic downturn, is also over. The need to hire, build capacity, ensure strong supply, advertise and retool distribution and sales is driving up costs faster than revenue for the average listed company. Our proprietary models that correlate factor returns to analyst consensus estimates confirm the same — economy-wide earnings momentum is close to stall-speed.

For equity markets that have already captured high multiples, earnings disappointment will be a major challenge. Couple that threat with concerns about slower growth or higher inflation – or both as the rate of inflation – courtesy of price and wage increases that are proving to be more widespread, persistent, and stronger than central bankers or economists. Huh. And suddenly the slippery path of the market appears bumpy, even uncertain.

Over the past year, investors have largely adopted a “see no bad, hear no bad” attitude when it came to the idea that earnings growth would flatten as monetary policy tightened. They were swayed by the belief that the future could be contemplated tomorrow. The transitory not only defined a benign inflationary soft-landing, but also stood for the enduring Goldilocks sentiment – ​​a future that is never influenced by the present.

Omicron is highlighting the uncertainty of such thinking. The future cannot be postponed any longer. it has arrived.

Such guest comments are written by writers outside of Barron’s and Marketwatch newsrooms. They reflect the perspective and views of the authors. Submit commentary proposals and other feedback [email protected],


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