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Article | 9-minute read

Omicron shatters market calm

December 2021

In late November, the emergence of a new COVID-19 variant spooked financial markets. Despite the chaos, our Chief Investment Office maintained a mild overweight to risk assets this month. Find out why in our latest House View.

 

Our view

November was looking like a relatively benign month for financial markets.

A fourth COVID-19 wave across Europe, the commencement of tapering in the US and the reappointment of Jerome Powell as Chair of the US Federal Reserve (Fed) all had the potential to roil markets. The coming and going of the 26th United Nations Climate Change Conference could also have bought disruption. Despite this, until the afternoon of Friday 26 November, markets had shown little signs of concern.

The Chicago Board Options Exchange's Volatility Index, or as it is more colloquially known, the VIX, had only risen 14% over the month; the MSCI World Index less than 1% and bond markets had behaved in a far more orderly fashion than the two months prior.

Enter B.1.1.529, or as it has since been renamed by the World Health Organisation (WHO), Omicron - the latest in a growing line of Greek letters used to describe variants of COVID-19.

Since designated as the newest variant of concern, Omicron, which was first reported in South Africa, shattered the calm as concerns rose about a significant stalling of the global reopening. International borders began snapping shut, the price of oil fell more than 10% - one of its biggest one day declines on record - and the Dow Jones Industrial Average finished 2.5% lower, its worst one day fall since October last year, as investors sold first and sought to ask questions later.

Stocks which have recently benefitted from the reopening trade were hardest hit as a rotation back towards the ‘stay at home’ theme took hold. Locally, Qantas shed more than 5%, while globally, travel and retail related shares fell sharply; this included Royal Caribbean Cruises and Unibail-Rodamco-Westfield - each falling more than 10%. Conversely, Zoom and HelloFresh rose approximately 5% while healthcare companies also benefitted - Moderna jumping more than 20% on the news. Potentially exacerbating the movements was the US Thanksgiving holiday, where traditionally thinner volumes of shares are traded than on average. Thinner volumes tend to result in more extreme swings as there are less traders available to take sell orders. On 26 November, fewer than 9 billion shares were traded on US exchanges, a stark contrast to the almost 11 billion traded on average. Bond markets weren’t immune to the panic, as investors sought a flight to safety, the yield on the US 10-year Treasury falling to 1.48%.

So far it is too early to tell what impact this latest variant will have on the global reopening and economies more broadly. Medical experts have called for calm in the face of rising fears, noting the globe is far better positioned to deal with a renewed crisis than it was 18 months ago. Vaccine technologies have advanced since the start of the pandemic, with proven rapid adaptability. Further, large parts of populations, at least amongst developed nations have high vaccination rates and central banks and governments have proven they are willing to backstop economies and financial markets, albeit their ammunition levels have now been severely depleted. This latest episode will provide further food for thought for central banks currently mulling over the potential unwind of policy measures.

This latest episode does serve as a reminder of the vaccine disparity - some commentators are labelling it a vaccine apartheid - between developed and underdeveloped nations and how important it is that all populations are inoculated. The latest variant is believed to have developed in a country where low vaccination rates and high levels of HIV (where immune systems are already weakened) result in a breeding ground rife for new variants. Until such time as this disparity is addressed the global economy remains vulnerable to further shocks.


MSCI world winners and losers 2021

What this means for our diversified portfolios

Until we get clearer signals for change, we remain mildly overweight risk assets, with no immediate plans to adjust portfolios because of the Omicron variant. Throughout the pandemic we have seen numerous examples of markets reacting swiftly to news, only to unwind the changes days later. No better example than in early 2020 when we saw the steepest bear market in history swiftly followed by the sharpest bull market recovery on record.

We continue to advocate for a long-term investment strategy and despite our mild overweight to growth assets, the diversified nature of our portfolios allows us to maintain some defensive positions which aid in downside protection during moments of extreme market movement.

We retain a very mild overweight to the USD and slight underweight to the AUD; the positioning serving as a form of protection during market sell-offs. Additionally, we maintain a mild overweight to unhedged global equities and mild underweight to Australian shares. This relative positioning and favouring of defensive/quality stocks versus cyclical shares should provide some benefit to portfolios. Finally, despite a mild underweight to duration, portfolios still hold significant duration exposure, which alongside our mild overweight to cash, should provide downside protection during this time.

ANZ investment strategy positions - December

Investment position
Asset class Reasoning
Growth Assets

 

Developed market shares

Developed markets equities, where we remain mildly overweight, continue to be our preferred exposure within growth assets. We forecast a bumpier ride for global shares until year-end but expect them to grind higher on the back of favourable seasonality, positive earnings momentum and the prevailing theme of TINA — ‘there is no alternative’.

Within developed markets we keep our somewhat balanced positioning, namely quality/growth exposure expressed by our position in the US, and cyclical/value exposure via Europe and Japan. If a more volatile pathway does play out, ‘quality’ shares are expected to outperform — as seen in late November. ‘Value’ on the other hand should provide some hedge to inflation risk in the portfolio.

Australian shares

We remain at benchmark, albeit marginally below neutral in Australian shares this month.

Our outlook for Australian shares hasn’t changed materially since last month - namely there is better diversification and earnings momentum abroad. A challenging outlook for local earnings momentum and potential implications for commodity prices stemming from slowing growth and increasing environmental regulations in China are the main headwinds for the market - particularly Materials, which accounts for a significant portion of the index. If the reopening of international orders isn’t impacted too much by the new variant, then this should be a boon for education and tourism sectors - although it is likely to be some time before it is solidified due to the gradual nature of the reopening. As noted previously there is still scope for the ‘value trade’ to re-emerge this year if labour market conditions remain tight, inflation persists, and bond yields shift higher. Given the recent underperformance of ‘value’ shares, if this eventuates, we may consider increasing our position.

Emerging-market shares

Valuations remain very cheap relative to developed markets, and at some point we believe investors are likely to find this too compelling to overlook. For now, the outlook for emerging markets is too opaque and we want to see some easing in risks before potentially increasing our position here. Key catalysts which could lead to an increase in relative positioning include a combination of a shift higher in real yields, US dollar weakness - which is traditionally a tailwind for the asset class - and/or the easing of geopolitical tensions across key areas. While a slowing Chinese economy and the implementation of regulations is also of concern, policy loosening here whilst others are tightening could also be a catalyst to build our position.

As a result, we remain at benchmark to emerging markets shares this month (albeit slightly below neutral due to drift) and await further signals before additional consideration is given to increasing our position.

Listed real assets

We are mildly underweight listed infrastructure and are benchmark to Global REITs. The construct of which is a mild underweight to listed real assets.

Given the 12-month performance of GREITs we have less conviction for near-term outperformance from the asset class. While GREITs could be a beneficiary if the ‘value trade’ re-emerges later this year an increase at this stage would undo our current mild dislike for duration. Given this we remain at benchmark based on the benefits the asset class provides to portfolios - namely an attractive dividend yield, diversifying effect for multi asset portfolios and hedge against inflation.

Listed infrastructure has continued to disappoint and its underperformance versus global shares reached its widest point on a 12-month basis during November. Despite large fiscal spends and global promises of investment in infrastructure, the long-duration nature of these assets, the outlook for rates and resulting potential of a rise in valuations has kept the asset class subdued and our hopes of a strategic opportunity to increase exposure non-existent.

Foreign Exchange Hedge Ratio*

The AUD has seen sharp swings in recent months. Strong domestic growth expectations and easing asset market volatility in China saw a sharp rebound in the AUD over October. This was followed by a steep retracement in November as Governor Lowe reiterated Australia’s cautious stance on raising rates and a conversely hawkish narrative out of the US saw demand increase for the greenback.

Looking ahead we believe the prospects of a broad stabilisation in global growth should counter risks of tighter policy expectations leaving us with the view that the AUD should be range bound in the near-term.

Within our diversified portfolios we maintain our benchmark position, albeit slightly below neutral, to the AUD this month. We prefer more developed market foreign currency exposure (in particular the USD) which should act as a form of protection in the event of any equity market pull-back.

 
Defensive Assets

 

International fixed income

Our outlook for fixed income remains consistent with previous months and we maintain our mild dislike for duration in portfolios. Jerome Powell’s reappointment as US Federal Reserve Chair has led to a more hawkish view from market participants. Coupled with the commencement of tapering and inflation being stickier than initially expected this has most analysts expecting at least one rate rise from the Fed in 2022.

With the prospect of higher yields we remain at benchmark this month and continue to favour global bonds to domestic bonds, owing to our preference for credit versus sovereign bonds. The global market has a higher credit allocation than the Australian market and credit should outperform sovereigns in the near-term given continued monetary policy support, the hunt for yield and broader economic prospects.

Australian fixed income

Australian fixed income remains our least preferred asset class within defensive assets. It’s the composition of the Australian bond market, alongside its propensity to act as a higher beta market than many of its global peers, which frames our relative positioning. We continue to favour credit versus sovereign bonds and the domestic market has a higher allocation to sovereign debt than the global bond market. Despite our mild dislike for duration and the fact the local market typically has shorter duration than its global peers, in the event of broad-based sell-off in bonds we would expect the domestic rates market to move more aggressively than global peers due to its higher beta. Therefore, we are mildly underweight Australian fixed income as a result. The October sell-off in domestic bonds saw our underweight to the asset class drift lower. While domestic bonds remain our least preferred asset class, the sell-off took us well below benchmark and any major shocks could have unwound the gains made to portfolios in October. As a result of these factors, we have rebalanced Australian bonds back to those levels held prior to the recent sell-off. We are underweight Australian fixed income.

Cash

We hold a benchmark position in cash. The position provides liquidity and risk reducing characteristics to portfolios.

 

Notes:

*Percentage of developed market and emerging market equities hedged from foreign currency into Australian dollars.

Tactical Asset Allocation is current as at 1 December 2021.

 

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