COVID Returns to the Forefront
Unlike my Thanksgiving meal that finished on a sweet note of pumpkin pie, stocks concluded the holiday shortened week with a sour tone as the S&P 500 dropped -2.3% on Friday. The decline was spurred by news that a new variant of COVID-19, the Omicrom strain, may be spreading. For the week, the S&P 500 finished lower by -2.2%, with small cap stocks getting hit the hardest, down -4.2%.
The Omicrom strain was first identified on November 11th and has thus far been largely reported in parts of Africa. Much remains to be known about it. However, the variant has 32 mutations from the initial COVID-19 virus, which have some fearing that vaccines may be less effective against this strain. The unknown stoked fears of more restrictions, which could fuel a pullback in economic activity.
Friday’s about face for the market seemed a little bit too reactionary at first blush. While we all hope for the COVID-19 virus to be behind us, it’s not illogical to expect added strains and additional flareups. Stock prices have, however, performed well throughout 2021 as they have priced in the significant improvements in the economy and better than expected corporate earnings. In fact, the S&P 500 is up +7.1% from the October 4th low that was set following the recent September pullback. As news about the Omicrom variant causes some to reexamine their expectations around future earnings, a modest retrenchment in prices is not illogical.
Friday’s market reaction was very much risk off in nature. Bond yields, which had been marching higher in response to higher inflation data, dropped, with 2-year Treasury yields finishing the week near where they began at a rate of 0.5%. Alternatively, the 10-year Treasury yield fell 7 basis point to 1.48%. Yields had been aggressively climbing earlier in the week, with the 10-year reaching 1.67% on Tuesday before plummeting at weeks end. In addition to bonds, other flight to safety assets held up well. Case in point, gold, which had been falling throughout the week, rallied +0.8% on Friday.
While researchers are still seeking additional information and data around the Omicrom variant, we are in a much better place than we were in early 2020. The economy has learned how to adjust to changing regulations. More widespread vaccinations will only help to control the impact of added strains of the virus. Moreover, researchers are further ahead in being able to develop added vaccines or boosters to help combat additional strains. Overall, we believe there is a strong underpinning to the economy and don’t see another variant derailing the recovery. Conditions could at times become a little softer, or as we’ve seen with recent inflation data, also become a bit too accelerated.
If anything, a day like this past Friday is a good reminder for the need to have balance in a portfolio. The assets that are going to work well during episodes of a COVID flareup are likely to be different than those that will do well in a cyclical economic recovery. For example, bonds served the role of diversifying assets on Friday, having added three quarters of a percent of return on a down day for stocks. Previously, bonds were a drag on results having experienced a negative return throughout the fourth quarter up until Friday. Maintaining balance within portfolios and playing the long game is the approach we advocate in this environment.
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