Stocks and oil tank as Covid makes another appearance, but can pharma come to the rescue?
Just when we thought that Covid was behind us and all we had to worry about was the pace of central bank tightening, the markets received a jolt from news that a new variant, the B.1.1.529, could evade vaccines and was transmitting faster than the Delta variant. This new variant was first identified in Botswana and has already spread throughout Southern Africa, although for now the number of cases remains fairly low. However, that did not stop the UK authorities from taking immediate action including placing six southern African countries back on its red list and suspending flights to South Africa and elsewhere. The effect on financial markets was immediate, Asian stock indices fell sharply, the Nikkei was down more than 2.5% overnight, and European indices are down more than 3% at the open. The yen has surged, as investors rushed to safe havens, and US stock market futures are also sharply lower as we wait for the holiday-shortened US markets to open later today.
Is a Santa rally off the cards?
The market has been fairly nonchalant about Covid, even with case rates rising sharply across Europe. However, this new variant is likely to knock risk and may even jeopardise the prospect of a “Santa rally”, where markets traditionally move higher in the run-up to the festive season. Although authorities in the UK acted quickly on Thursday evening to try and stop the spread of this new Southern African variant, we are still expecting cases of it to be found in the UK and elsewhere in the coming days or weeks. If this happens, expect markets to take another lurch lower. This is the scenario that virologists and epidemiologists have been fearful of even as markets have been fairly sanguine about future Covid threats: a strain that is vaccine resistant. This comes at the worst possible time for Europe and the US, just as winter sets in. The chief concern for investors when it comes to new Covid variants, aside from the health of themselves and loved ones, is the prospect of new economic lockdowns being imposed to combat its spread. Right now, the prospect of economic lockdowns is impossible to predict, hence the decline in asset prices. However, there could be one way back for risk sentiment in the coming days.
Pharma to the rescue, again
The silver lining to this new variant is that the vaccines that we already have to fight Covid, in particular the Pfizer vaccine, is easily adjusted to combat new strains. I am no epidemiologist, thus we should wait to hear from the actual scientists and executives at Pfizer, Astra Zeneca and elsewhere, before piling back into risk. However, if they can reassure the world that vaccines will be adapted to combat this variant then we may see stocks rise, volatility fall, and the dollar rise again vs. the yen. In this environment, traders need to be reactive to any news that comes out about this variant, which could make markets volatile in the short term.
Airlines, ZAR and oil at risk
In terms of products that could be most at risk from the Covid news, we think that airlines and ZAR crosses may be hardest hit in the coming days. While pharma stocks and other defensive sectors such as utilities could outperform. The yield on Treasuries, another safe haven asset, has tumbled overnight, with the 10-year yield down to 1.54%, after reaching 1.65% earlier this week. Commodities have also come under severe pressure; the price of Brent crude is down more than 3.5% to $79.35 at the time of writing. The risk for longer term investors is that the usual Santa rally in stock markets may be disrupted this year by the new Covid variant. We think that it depends on how far this new variant has spread and how quickly vaccines can be adapted to combat it. However, a new Covid variant plus stock markets that have had a strong rally this year, the S&P 500 is up approx. 25%, could make investors jittery about pushing markets higher as we move to the end of the year.
Black Friday and retail stocks
Black Friday places the focus on retail stocks as we end the week. So far, the performance of this sector has been mixed, the S&P 500’s consumer discretionary sector has backed away from record highs in recent days. This week there was some good news for Kohls, the make-up brand, which jumped 10% after better-than-expected sales growth. However, there was bad news for Gap and Nordstrom, whose shares dropped 20%, as both US retailers reported a jump in shipping costs and inventory issues, especially with women’s apparel. This year, soaring inflation means that it will be harder to find Black Friday bargains, however, this is not expected to hurt sales, with the UK predicted to spend £8.7bn, up from £7.8bn in 2019, according to PwC.
In the lead up to the shopping season, Marks & Spencer’s stock price has continued to soar this month and is currently at its highest level since April 2019. We may see further gains if it experiences a strong Black Friday, however, when it comes to retail, we urge traders to be picky: only trust the names that have done well in Q3 earnings season, as they have proven that they have the expertise to deal with supply chain problems etc. We still expect the retailers to be impacted by the sell off on the back of the latest Covid news, so tread carefully. While we think this market sell off will enable traders to buy assets at more attractive levels, we do not think that this will happen until we get some reassuring news that: 1) the new Covid variant has not spread from Southern Africa and it can be contained, and 2) that vaccines can be adjusted to deal with it. However, we caveat this by saying anyone looking to take short positions in risk as we move to the end of the week, should choose wisely. For example, we think that the oil price could be more at risk in the short term than some retail names, who may weather this Covid storm better than other sectors if Black Friday sales are as strong as expected.
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