BlackRock Commentary: Virus spike to delay, not derail restart

Wei Li, Global Chief Investment Strategist together with Alex Brazier, Deputy Head, Yu Song, Chief China Economist, Paolo Puggioni, Data and Innovation Manager and Michel Dilmanian, Member of Investment Strategy team, all forming part of the BlackRock Investment Institute, share their insights on global economy, markets and geopolitics. Their views are theirs alone and are not intended to be construed as investment advice.

The new year has started with a record COVID surge, renewed restrictions and many people working from home again. The difference with this time: The Omicron strain appears less severe in populations with high vaccination and immunity rates. We see Omicron delaying – and not derailing – the powerful restart of economic activity while potentially adding to supply bottlenecks. We stay overweight equities and eye risks that policymakers or markets misread the current surge in inflation. 

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Past performance is not a reliable indicator of current or future results. Indexes are unmanaged and not subject to fees. It is not possible to invest directly in an index. Sources: BlackRock Investment Institute, with data from UK Coronavirus (COVID-19) Dashboard . Notes: Chart shows London COVID-19 cases and hospital admissions compared with their January 2021 peak level. Hospital admission data are adjusted by seven days to account for the lag between cases and admissions

 

Markets have started the new year on a jittery note, with worries centering on Fed rate rises and policy normalization. We urged investors to stay invested through COVID-related volatility as we believed the strain would ultimately only delay the powerful restart of economic activity that has underpinned a surge in corporate profits. More clarity on Omicron in the past weeks has strengthened our conviction, even as the COVID surge may look frightening. Why? First, vaccines and prior infections have proven effective against severe disease even as their efficacy against Omicron infection has fallen. Second, scientific studies are suggesting Omicron is intrinsically somewhat less severe than previous strains. Third, populations have gained higher immunity as more people have caught COVID or received boosters. All this suggests a surge in cases but a more muted rise in hospitalizations. We view the situation in the recent Omicron hot spot of London  as a harbinger of things to come. Case loads spiraled upward to almost double the previous peak in early 2021 (the red line in the chart). Yet hospital admissions have remained 50% below the earlier highwater mark (the yellow line). 

Both case loads and hospitalizations in London have started to come down, suggesting the worst of the Omicron wave may be over. We expect other areas to follow a similar pattern over the next couple of months. The caveats: Outcomes will likely be worse elsewhere as the UK sports high vaccination, booster and immunity rates. And pressure on hospitals and services in general is set to mount as they already face staff shortages. Check out our COVID-19 tracker for the latest trends.

The key question is how China’s zero-COVID policy will stand up against Omicron. The policy so far has proven effective and enjoyed popular support, but has left China with almost no natural immunity. We expect the country to maintain the policy – at least optically – in this politically important year. This raises the spectre of more restrictions on activity, from targeted measures that keep the economy humming (Shanghai)  to full-scale lockdowns (Xi’an). As a result, we believe downside risks to China’s growth have risen, even as Beijing appears bent on achieving its growth target this year by loosening policy. The big picture on Omicron remains that we see it only delay the powerful global restart. Less growth now means more growth later, in our view. Omicron also may have a silver lining. Its highly infectious nature may turn COVID into an endemic disease similar to the flu as populations build up immunity and annual booster shots keep down the human toll.

Risk assets showed clear concern about the Fed over Omicron last week. Policymakers and markets may misread the unique mix of the restart, a mutating virus, supply-driven inflation and new central bank policies. Our base case: Central banks take their foot off the gas pedal to move away from emergency stimulus. We expect them to live with inflation, rather than hit the brakes by raising rates to restrictive levels. The Fed has signaled three rate rises this year – more than we expected. Markets seem primed to equate higher rates as being negative for equities. We’ve seen this before and don’t agree. What really matters is that the Fed has kept signaling a low sum total of rate hikes, and that didn’t change last week. This historically muted response to inflation should keep real policy rates low, in our view, supporting equities. And not all spikes in long-term yields are the same. Last week’s jump in U.S. Treasury yields was about the Fed signaling a readiness to start shrinking its balance sheet. This could result in a return of term premium that typically demand to hold long-term bonds. But this is not necessarily negative for risk assets but can reflect an investor preference for equities over government bonds. Our bottom line: We prefer equities and would use COVID-related selloffs to add to risk. We are underweight DM government bonds – we see yields gradually heading higher but staying historically low.

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Past performance is not a reliable indicator of current or future results. Indexes are unmanaged and do not account for fees. It is not possible to invest directly in an index. Sources: BlackRock Investment Institute, with data from Refinitiv Datastream as of January 7, 2022. Notes: The two ends of the bars show the lowest and highest returns at any point over the last 12-months and the dots represent current 12-month  returns. Emerging market (EM), high yield and global corporate investment grade (IG) returns are denominated in U.S. dollars, and the rest in local currencies. Indexes or prices used are, in descending order: spot Brent crude, MSCI USA Index, MSCI Europe Index, ICE U.S. Dollar Index (DXY), MSCI Emerging Markets Index, Bank of America Merrill Lynch Global High Yield Index, J.P. Morgan EMBI Index, spot gold, Refinitiv Datastream Italy 10-year benchmark government bond index, Bank of America Merrill Lynch Global Broad Corporate Index, Refinitiv Datastream Germany 10-year benchmark government bond index and Refinitiv Datastream U.S. 10-year benchmark government bond index.

 

Market backdrop

Stocks and bonds fell after minutes from the Fed’s December meeting indicated a potentially faster-than-expected policy normalization, including speeding up the timeline for trimming its bond portfolio. The big picture remains that major central banks have indicated a historically muted response to rising inflation. This should keep real yields negative and support equities. We see inflation settling at a level higher than pre-COVID even as pressures from supply bottlenecks ease.

Week Ahead

  • Jan.10-17  – China money and credit data; Euro area unemployment rate
  • Jan.12 – China and U.S. CPI inflation data
  • Jan.14 – U.S. industrial production and University of Michigan sentiment

Investors will get a read on the persistence of U.S. consumer price inflation this week, while Chinese credit data may provide clues on the speed of policy loosening. The powerful economic restart has driven U.S. inflation rates to its highest rate in decades. This means the Federal Reserve has clearly met its average inflation target under its new framework, helping open the door for interest rate rises this year.


BlackRock’s Key risks & Disclaimers:

This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of January 10th, 2022 and may change. The information and opinions are derived from proprietary and non-proprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by BlackRock, its officers, employees or agents. This material may contain ’forward looking’ information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this material is at the sole discretion of the reader.

The information provided here is neither tax nor legal advice. Investors should speak to their tax professional for specific information regarding their tax situation. Investment involves risk including possible loss of principal. International investing involves risks, including risks related to foreign currency, limited liquidity, less government regulation, and the possibility of substantial volatility due to adverse political, economic or other developments. These risks are often heightened for investments in emerging/developing markets or smaller capital markets. 

Issued by BlackRock Investment Management (UK) Limited, authorized and regulated by the Financial Conduct Authority. Registered office: 12 Throgmorton Avenue, London, EC2N 2DL.


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This information has been accurately reproduced, as received from  BlackRock Investment Management (UK) Limited. No information has been omitted which would render the reproduced information inaccurate or misleading. This information is being distributed by MeDirect Bank (Malta) plc to its customers. The information contained in this document is for general information purposes only and is not intended to provide legal or other professional advice nor does it commit MeDirect Bank (Malta) plc to any obligation whatsoever. The information available in this document is not intended to be a suggestion, recommendation or solicitation to buy, hold or sell, any securities and is not guaranteed as to accuracy or completeness.

The financial instruments discussed in the document may not be suitable for all investors and investors must make their own informed decisions and seek their own advice regarding the appropriateness of investing in financial instruments or implementing strategies discussed herein.

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Notes from the Trading Desk – Franklin Templeton

Franklin Templeton’s Notes from the Trading Desk offers a weekly overview of what our professional traders and analysts are watching in the markets. The European desk is manned by eight professionals based in Edinburgh, Scotland, with an average of 15 years of experience whose job it is to monitor the markets around the world. Their views are theirs alone and are not intended to be construed as investment advice.

The Digest

There were some notable moves in equity markets last week following a spike in bond yields as concerns rose over a more hawkish Federal Reserve (Fed). The minutes from the latest Federal Open Market Committee (FOMC) meeting revealed that the Fed was growing more confident that the US economy was ready for a broad-based removal of monetary accommodation, and the Omicron variant was unlikely to slow it down. COVID-19 continued to be a key focus for investors, and last week, attention shifted to the trends in hospitalisations following the surge of Omicron cases over the last few weeks. The initial decoupling of cases vs hospitalisations in Europe gave investors hope that recently enforced economic restrictions will be temporary. Outside of Europe however, Omicron cases continue to surge in the United States and China locked down a further two cities on relatively very low case numbers.

FOMC Minutes and the Credit Markets

The key focus for markets last week was the release of the minutes from the latest FOMC meeting. Investors were on the lookout for any hints around whether the committee still viewed inflationary pressure as transitory and for further reasoning behind the accelerated tapering decision. The minutes were released last Wednesday and the thoughts among board members were that interest-rate hikes may need to start earlier or at a faster pace than previously anticipated. Some also flagged the possibility of shrinking the Fed’s balance sheet relatively soon after raising rates. Assessment of Omicron risks were focused more on the potential for exacerbating inflation pressure rather than hampering economic growth. Many saw full employment as not far off and suggested the labour market needs to be monitored for inflationary pressures. Equally important is how the US Treasury adjusts its issuance in response to reduced Fed reinvestments and until all of this is clarified, it will create significant bond/equity negative uncertainty for the market. With all said and done, consensus on the minutes is the Fed recognises it is behind the curve on inflation and now is the time to play catch up.

Bond yields were on the move after the FOMC minutes suggested it could be appropriate to begin to reduce the size of the Fed’s balance sheet relatively soon after beginning to raise rates. Given the size of the Fed balance sheet, there is concern for risk assets when it begins to contract. Last week’s events saw the US 10-year Treasury yield rise 16.7 basis points (bps) to 1.76% and above the 1.75% resistance level which held over the course of 2021. Also, five-year real yields reached pre-COVID-19 highs last week. Bond yields spiked in Europe last week, too. December’s Consumer Price Index (CPI) print came in at a new high of 5% and triggered a notable backup in rates. European credit markets made an all-time high on Tuesday. The German 10-year Bund yield rose 13.6 bps to -0.047%, the highest level since 2019.

Rotation, Rotation, Rotation

As a result of the move in credit markets, we saw a global derating in growth stocks, which naturally weighed on broader indices. In Europe, the Morgan Stanley Value Index closed last week up over 10%, with the equivalent Momentum Index relatively flat overall. This rotation into value stocks was dovetailed by a clear push into cyclicals. Cyclicals in Europe closed the week up 6.2%. Sector dispersion between best and worst was over 11% last week. The banks outperformed in Europe, closing higher with the rate rhetoric improving rising. Automobiles weren’t far behind, having benefitted from that rotation into value. Basic resources also moved higher last week, having benefitted from a headline suggesting China may ease policy in the first quarter 2022.

Outside the broader sector beats, it is worth noting that European airlines enjoyed an early 2022 reprieve, closing the week sharply higher. Technology stocks were the key laggards last week given weakness in the United States. Health care stocks also had a tricky week, closing lower. As investors engaged on the reopening trade to start the year, it appears some of the outperforming pharma stocks were sold to fund these moves.

Most of the moves in Europe were driven by moves out the United States. US technology stocks finished the week lower, and that and the underperformance from technology heavyweights weighed on broader US indices. The S&P 500 Index closed the week down 1.9%, whilst the Nasdaq closed the week down 4.5%, its worst week since February 2021. Like in Europe, last year’s health care winners were sold last week to fund the move into value stocks, and the sector saw losses last week. Real estate investment trusts (REITs), one of last year’s outperformers, also lagged last week.

At the other end, given the strong rally in cyclicals, energy stocks closed the week higher, as West Texas Intermediate crude oil moved back above US$80 for the first time since November. Financials were also strong.

The big question from here is: will the rotation continue? Some argue that last week’s move should have taken place in the fourth quarter of 2021, but was delayed due to the spread of Omicron. The big picture does continue to improve on the COVID front though.

Week in Review

Europe

European equity markets emerged from the festive holiday season with some gusto last week. A variety of themes, some new and some existing, were evident as investors returned. Omicron continues to be a focus. Reopening stocks were bought and some of the “Stay-at-Home” stocks were very weak as optimism rose over the improving picture of Omicron in Europe. Goldman Sachs’ “Going Out” basket closed the week up 5.2%, whilst the equivalent Stay-at-Home stocks were down 5.5% last week.

Investors in Europe had one eye on the minutes from the latest FOMC meeting. On the political front, the protests against fuel price rises in Kazakhstan in the past week have garnered attention in the region. Meanwhile, the Italian presidential appointment and the French presidential election should become more of a focus in the weeks and months ahead. There was a clear rotation into value as noted, with hedge funds shifting out of last year’s outperformers and into last year’s underperformers.

The first half of 2022 brings a couple of European political events to keep an eye on, with a new Italian President due to be appointed and French presidential elections upcoming. The seven-year reign of Italian President Sergio Mattarella ends on 3 February 2022. The public does not elect his successor; rather, he or she will be appointed by an electoral college comprised of the members of the Parliament and regional councils.

While the presidential role is largely ceremonial, this election is important as technocrat Prime Minister Mario Draghi could be a candidate, and if he were to run and be elected, we could see a period of uncertainty with fresh elections possible. Draghi has been a calming influence on the volatile Italian political landscape and has successfully implemented various reforms. The Italian stock market performed well last year, up 22%, so his departure for a more passive role would be seen as a negative for markets. In addition, polling in Italy suggests a right-wing, Eurosceptic government is a possibility should elections be held, with the Northern League and Brothers of Italy polling around a combined 40% of the vote. A return to a more combative Italian government could create tensions within the European Union (EU)—another potential headwind for equity markets.

A bit further out, in April, we have a French presidential elections. As it stands, this could be a more benign event than some may have anticipated. The right wing, Eurosceptic Marine La Pen has been nudged into third in polls by the centre right candidate, Valerie Percesse. If this remains the case in April and the second-round vote was between Macron and Percesse, it would appear the outcome for markets is far more favourable for Le Pen not being involved. A lot of water to go under the bridge yet—but encouraging signs from a market perspective at this stage.

Las week was very turbulent for Kazakhstan, with initial protest demonstrations occurring due to the doubling of liquefied petroleum gas (LPG) prices on 2 January. Despite the authorities very rapidly agreeing to cap LPG prices at below pre-increase levels, protests continued, and demands became more structural. On Wednesday, President Tokayev accepted the resignation of the cabinet and declared a state of emergency (including closing the Kazakhstan Stock Exchange) as a result of these wider protests.

Russia sent in what it calls “peacekeepers” to support President Tokayev in his efforts to quell protests and restore order. This Russian move supports the idea that there is little risk of a major threat to the long-standing, authoritarian political system.

Assuming no additional deterioration in the coming days, the main consequence would be a further consolidation of power for President Tokayev and possibly some faster steps towards democratisation. However, if things go the other way, then concerns around the involvement of Russian troops, the wider Russian market, uranium and the price of oil, etc. will come under much more scrutiny.

United States

We saw an eventful start to the year with some notable moves on the back of changing expectations regarding Fed policy (as discussed above). The S&P 500, Nasdaq 100 and Russell 2000 indices all lost ground last week. Underneath the hood, we saw a huge rotation out of growth and into value.

Given the move lower, the S&P 500 Index is once again testing its 50-day moving average, a key support level in recent times.

Looking to the bond market, last week’s events drove the US 10-year bond yield up 16.7 bps to the 1.76% area, and above the 1.75% resistance level that held over the course of 2021.

In terms of sector performance, the move in rates caused a shock in the tech sector, as noted. Last week, energy and financials were higher as value names surged higher in the new year.

Looking to US macro data, last Friday’s December employment report was the main focus, with the US unemployment rate falling to 3.9% (the first time it has been sub 4% since February 2019). In terms of jobs added, the number actually missed expectations, coming in at 199,000. December jobs data also showed that average hourly earnings growth continues to exceed expectations at +4.7% year-on-year. Overall, the impression was that there was nothing in the data to change the Fed’s new hawkish path.

Elsewhere, Democratic Senator Joe Manchin remains at loggerheads with the White House over President Biden’s proposed US$1.8 billion “Build Back Better” stimulus bill. The bill remained stalled due to Manchin’s opposition.

Asia Pacific

2022 started with a mixed bag for Asian market performance. Hong Kong’s equity benchmark edged slightly higher last week, and Australian equities were essentially unchanged. However, equities in South Korea, Japan and mainland China all started the year with declines.

Focus in China remains on the COVID-19 situation with a hard-line approach seeing a number of regions in lockdown. The latest was Tianjin, with a population of 14 million, which went into lockdown in response to at least two cases of the Omicron variant discovered over the weekend. With the Winter Olympics looming large and an influx of competitors set to arrive, if cases rise there will be concerns over the threat to China’s economic plan and potential supply-chain disruptions.

There were a few other interesting headlines from China last week. China’s securities watchdog Chairman Yi Huiman told state television that it will adopt multiple measures to “firmly” prevent market volatility. On the property front, Chinese regulators have asked banks to increase lending to the sector this quarter and eased a key restriction that has held back acquisition activity.

Week Ahead

Monday 10 January:

  • Italian unemployment rate
  • Eurozone unemployment rate
  • US wholesale inventories

Tuesday 11 January:

  • Spanish industrial production (IP)/output
  • Italian retail sales
  • US NFIB small business optimism

Wednesday 12 January:

  • Eurozone IP
  • US CPI
  • China CPI, Producer Price Index (PPI)

Thursday 13 January:

  • Italian IP
  • US PPI (excluding food and energy)

Friday 14 January:

  • UK monthly gross domestic product (GDP), IP, manufacturing production, construction output
  • French CPI
  • Spanish CPI, trade balance
  • US University of Michigan sentiment, retail sales (excluding automobiles and gas), import price index, IP
  • China trade balance

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This article reflects the analysis and opinions of Franklin Templeton’s European Trading Desk as of 10 January 2022, and may vary from the analysis and opinions of other investment teams, platforms, portfolio managers or strategies at Franklin Templeton. Because market and economic conditions are often subject to rapid change, the analysis and opinions provided may change without notice. An assessment of a particular country, market, region, security, investment or strategy is not intended as an investment recommendation, nor does it constitute investment advice. Statements of fact are from sources considered reliable, but no representation or warranty is made as to their completeness or accuracy. This article does not provide a complete analysis of every material fact regarding any country, region, market, industry or security. Nothing in this document may be relied upon as investment advice or an investment recommendation. The companies named herein are used solely for illustrative purposes; any investment may or may not be currently held by any portfolio advised by Franklin Templeton. Data from third-party sources may have been used in the preparation of this material and Franklin Templeton (“FT”) has not independently verified, validated or audited such data. FT accepts no liability whatsoever for any loss arising from use of this information and reliance upon the comments, opinions and analyses in the material is at the sole discretion of the user. Products, services and information may not be available in all jurisdictions and are offered by FT affiliates and/or their distributors as local laws and regulations permit. Please consult your own professional adviser for further information on availability of products and services in your jurisdiction. 

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MeDirect Disclaimers:

This information has been accurately reproduced, as received from Franklin Templeton Investment Management Limited (FTIML). No information has been omitted which would render the reproduced information inaccurate or misleading. This information is being distributed by MeDirect Bank (Malta) plc to its customers. The information contained in this document is for general information purposes only and is not intended to provide legal or other professional advice nor does it commit MeDirect Bank (Malta) plc to any obligation whatsoever. The information available in this document is not intended to be a suggestion, recommendation or solicitation to buy, hold or sell, any securities and is not guaranteed as to accuracy or completeness.

The financial instruments discussed in the document may not be suitable for all investors and investors must make their own informed decisions and seek their own advice regarding the appropriateness of investing in financial instruments or implementing strategies discussed herein.

If you invest in this product you may lose some or all of the money you invest. The value of your investment may go down as well as up. A commission or sales fee may be charged at the time of the initial purchase for an investment. Any income you get from this investment may go down as well as up. This product may be affected by changes in currency exchange rate movements thereby affecting your investment return therefrom. The performance figures quoted refer to the past and past performance is not a guarantee of future performance or a reliable guide to future performance. Any decision to invest in a mutual fund should always be based upon the details contained in the Prospectus and Key Investor Information Document (KIID), which may be obtained from MeDirect Bank (Malta) plc.

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