Familiar Unknowns

Friday Reflection | December 3, 2021

The market has been a roller coaster since last Friday, rising or falling by more than 1% each day as investors oscillate between optimism and pessimism. The primary culprit has been the emergence of a new COVID variant in South Africa. The cycle of alarmist headlines, rapidly shifting travel restrictions, and fear of backward progress brings up all too familiar memories of last spring.¹
 
This cycle feels different. We have perspective and knowledge accumulated through research over the past year. Many communities – including the Bay Area – are majority vaccinated and new treatments are arriving soon to expand our toolkit for treating infected patients.² Even as the spectre of a winter surge looms, the collective viewpoint is slowly shifting away from a pandemic mindset. This makes sense as we approach an endemic phase characterized by more virus variation, but also by more continuity of daily life and business.

While the emergence of the Omicron variant is troubling as a public health issue, it is familiar territory for the economy. Early reports indicate that Omicron is more transmissible, but it may also be less deadly, which would fit into the pattern of virus evolution observed historically.³ This variant may thus be the signal of a transition to a manageable endemic phase of COVID, which could be long-term positive for economic growth. The resilient optimism we observe in markets is encouraging, as long as it isn’t accompanied by complacency.

Investors are understandably hesitant at this early stage of understanding the new variant. Adding to this uncertainty are mixed messages from executives at the major vaccine companies. A Pfizer executive said they “don’t expect that there will be a significant drop in effectiveness” of their current vaccine against the Omicron variant. That’s a starkly different view from the one that Moderna CEO Stéphane Bancel shared on Tuesday, saying he expected current vaccine effectiveness to see “a material drop,” adding that scientists have told him, “This is not going to be good.”⁴

The bottom line is we still don’t have clear answers. Per usual, the stock market isn’t waiting around to get the details. Investors will continue to make speculative adjustments until we have more certainty about Omicron. Even if virus fears ebb in the coming weeks, the market faces other bogeymen ranging from historically high valuations to persistent inflation to a labor market that is struggling to return to full employment.

One of the most closely watched metrics of the current economic recovery – and a general barometer of economic health even beyond a pandemic – is the national unemployment rate. That rate dropped to 4.2% in November as the US economy added 210,000 new jobs. After staggering unemployment figures during the early months of the pandemic, an unemployment rate of 4.2% seems pretty good. Compared with historical averages, it is good. It also doesn’t tell the full story.

Despite a relatively low level of unemployment, headlines keep highlighting a shortage of workers as the labor force participation rate has not recovered at the same pace. The participation rate is a measure of how many Americans are even desirous of a job. That rate stands at 61.8%, its highest level since March 2020, and yet it is still significantly below historical averages. Pre-pandemic the participation rate was approximately 63% and as recently as the early 2000s the participation rate was above 67%.⁵ Fewer Americans are working, and until the landscape of good jobs and safe childcare options shifts, the number of workers standing on the sideline may continue to be a drag on the economy.

Given Federal Reserve’s recent pivot toward greater concern about inflation made the November jobs report even more consequential than it otherwise would have been. Investors will incorporate this slower pace of job recovery and participation into their speculation about whether the Fed will raise interest rates sooner than the anticipated timeline of late 2022. While we view normalized interest rates as a positive for long-term growth, we expect that any surprises of a more accelerated timeline would result in short-term volatility in equity markets.

Neither the prospect of rising interest rates nor the uncertainty over a new coronavirus variant are new issues. These are familiar problems for investors, and we don’t think the news from the past week materially changes the staggered trajectory of economic recovery.

Even if the long-term growth prospects remain intact, constant concern about disruptive change can be exhausting. Investors are no more immune to these emotional responses than anyone else.⁶ At North Berkeley, we have conviction that market timing is impossible for anyone to implement effectively and consistently, despite the allure of doing so. Throughout history, markets have reverted to long-term averages and rewarded investors who resisted reactionary changes during periods of turbulence. It is with this understanding that we regularly and systematically rebalance client portfolios to keep them focused on the long-term.

The initial disruptions in the market in the spring of 2020 were disorienting and scary. Today, looking back almost two years later, we know that remaining invested while finding our feet again in our day-to-day lives was the right way to go. As we face new variants and risks, we believe this strategy will continue to serve our clients well.

Resources

¹ Biden to Toughen Testing for International Travelers to Slow Omicron WSJ

² The New COVID Drugs Are a Bigger Deal Than People Realize The Atlantic

³ JPMorgan Strategist Says Buy the Dip as Omicron May Accelerate Pandemic’s End. Bloomberg

⁴ Moderna chief predicts existing vaccines will struggle with Omicron Financial Times

⁵ Civilian labor force participation rate US Bureau of Labor Statistics (BLS)

⁶ How to Handle the Emotional Rollercoaster of Coronavirus Stress Cleveland Clinic