Uncertainty about the Omicron variant
The main reason for the unstable stock market climate has been uncertainty about the new Omicron variant of COVID-19. So far our knowledge about the new virus strain is limited. Omicron seems to be highly infectious but apparently does not generally result in severe illness. Hopefully we will gain a more complete picture of the new variant within the near future.
In the United States, uncertainty about Omicron caused the VIX volatility index to climb last week by 10 points to 31, its highest level since January 2021.
The United States
Federal Reserve signals faster tapering of its asset purchases
The US Federal Reserve has indicated that it will speed up the current reduction of its stimulative asset purchases. This increases the risk that it will hike its key interest rate earlier than the market had expected. Treasury Secretary Janet Yellen said last week that inflation is stickier than she previously thought, while former Treasury Secretary Lawrence Summers opined that the Fed should signal the possibility of four key rate hikes during 2022. The market foresees a 50% probability of a hike as early as May.
American labour market figures for November
Official job figures for November, which were published on December 3, were somewhat difficult to interpret. Non-farm payrolls rose by 210,000 − far below the market consensus of 550,000 − yet unemployment fell from 4.6% to 4.2%.
The Nordic countries
Swedish electricity prices keep setting new records
In Sweden, economic news headlines have been dominated by accelerating electricity prices and accelerating COVID-19 transmission. On December 7, electricity cost more than SEK 6.40 per kilowatt hour in southern and central parts of the country.
Norway imposes new restrictions
Due to increasing COVID-19 transmission the Norwegian government imposed new restrictions last week, in hopes of limiting the spread of the Omicron variant. They include mandatory use of face masks in crowded places, social distancing, working at home for those who can and limitations on restaurant services and large public gatherings. It remains to be seen whether these measures will affect the rate path of Norges Bank, which had previously communicated its firm intention to hike the key rate to 0.5% at its mid-December policy meeting.
Our market view
Uncertainty about outbreaks of the Omicron variant has shaken up stock markets. Preliminary reports in recent days about the limited risk of severe illness have had a calming effect. Although from a human perspective there are continued reasons for concern, we believe it will take a lot more negative news about the new virus strain before it has any major impact on economies and financial markets. This hypothesis is supported by the mild economic effects of recent COVID-19 waves and the fact that after nearly two years of the pandemic, we are learning to better manage any effects.
On the other hand, inflation worries continue to disrupt financial markets. The inflation surge of recent months has been both bigger and more long-lasting than expected, but so far it has been manageable in the markets. The same applies to current forecasts that inflation may climb further early in 2022, before declining. This is still our main forecast and that of most other observers – but it is now being challenged. Though it is unlikely that inflation will get stuck at the unusually high levels we see today, especially in the US, there is a growing risk that it will not fall to central bank target levels (around 2%). Continued inflation at higher levels than this will force central banks to act, including larger key rate hikes than in current forecasts.
This is not our main scenario, however. We are still expecting inflation to fall gradually next year, and we believe the US Federal Reserve can unwind its bond purchases as planned during the first half of 2022 and begin a period of key rate hikes during the second half. We believe the federal funds rate will reach 1.5% over the next two years and that 10-year US Treasury yields, a major alternative to equity investments, will be in the 2.5% range. These are yields that we believe are completely manageable for stock markets and investors, especially if our economic growth forecasts prove correct.
In our main scenario the global economic recovery will continue next year, with growth well above the historical average. By 2023 growth will fall to more “normal” levels. This suggests continued good earnings performance by listed companies, a thesis that is supported by their generally strong third quarter 2021 reports. The corporate sector continues to show an impressive ability to manage the challenges it is facing − currently dominated by shortages of components and other inputs.
We thus foresee some continued upside stock market potential for another while, but this presupposes that the Omicron variant can be managed without any major economic effects and that the inflation outlook will not worsen. But inflation in itself is not the only problem; if investors become more and more concerned about inflation, this may lead to rising interest rates and bond yields that have a negative impact on stock markets.
The turbulence we have seen in recent days is likely to persist for some time. We must probably expect greater share price volatility ahead than during the first six months or so of 2021. But assuming a relatively favourable trend in the above-mentioned risks, only a few weeks from today we should be able to look back at a very strong stock market year − when very robust earnings increases actually caused valuations to fall somewhat, despite share price increases. As long as interest rates and bond yields do not climb too rapidly, there are solid hopes that positive stock market returns will continue into next year.