The two main topics dominating short term stockmarket movements at the beginning of December are the removal of central bank support (in the form of purchases of government bonds and low interest rates implemented at the outset of the COVID pandemic) and the new Omicron COVID variant.
Rather bizarrely for those who might associate the ending of the COVID pandemic with rising stockmarkets and vice versa, the emergence of the Omicron variant has actually been seen as a positive by many stockmarket investors so far as it may result in the US Federal Reserve being slower to ‘taper’ the reduction in the stimulus support it has provided since the COVID pandemic started.
Over the last week stockmarkets have moved up and down sharply on a daily basis as the implications of the Omicron variant have been thought through by investors. Whilst the impact on the travel and leisure sectors is straightforwardly negative it is a fair conclusion that many other sectors would benefit more from an extension of US Fed stimulus support than they would suffer from an extension of the COVID pandemic.
It serves to highlight the fact that the dominant issue that underlies investor reaction to any newsflow at present is “what impact will this have on the US Fed’s stimulus reduction plans”. Anything that is likely to result in faster withdrawal of stimulus than is currently anticipated and a faster increase in interest rates, will almost certainly cause a short term sharp stockmarket correction.
That does though have to be an accepted risk for investors who need to embrace short term volatility as a trade off for the opportunity for long term returns. So long as interest rates remain low, even if they rise a bit from the current historically low base, the poor returns on cash will continue to encourage investors to take their chances on better stockmarket returns.
What is not an acceptable risk for investors is a prolonged fall in value of their investments: this could be triggered by sustained interest rate rises that choke off economic growth and would be a consequence of central banks having to chase out of control inflation. Whilst inflation is running hotter than central banks would like, it is not yet considered out of control but this could change as the impact of a tight labour market feeds into ever higher wages.
In conclusion, it doesn’t look like there is an obvious reason for stockmarket investors to be overly concerned in the short term but there is no doubt that the COVID stimulus has resulted in very high share valuations that would be difficult to justify in a higher interest rate environment.
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