What happened to Nu and Xi? Sasfin Month in Review – November 2021

Global equity markets have pulled back over fears of a new COVID-19 variant. Based on preliminary evidence, experts have raised concerns that the latest variant of the virus, which is named Omicron, poses an increased risk of infection. As a result, the MSCI All Country World Index (“MSCI ACWI”), a broad measure of global equity markets, ended November in negative territory, down more than 2% for the month.

The fall in global equity markets was broad-based as it was a negative month for all but one sector. Global energy stocks were the hardest hit with MSCI ACWI Energy sector ending the month down 7%. The price of Brent Crude fell by more than 15% during the month before closing at a little over $70 a barrel and its American counterpart, West Texas Intermediate (WTI), endured a 20% drop to end November at $66 a barrel. One factor that contributed to a fall in the price of oil was concern that the US Federal Reserve (“Fed”) would raise interest rates sooner than expected to combat rising inflation. This would in turn provide support for the US dollar which has an inverse relationship with the price of oil. Oil is priced in dollars and therefore fewer dollars would be required to purchase a barrel of oil.  The oil price felt additional downward pressure, specifically in the US, following President Joe Biden’s decision to authorise the release of 50 million barrels of oil from America’s strategic petroleum reserve in an attempt to drive down the escalating price of petrol in the US. Of course, a significant contributing factor to the drop in price has been the emergence of the Omicron variant and its potential negative impact on oil demand resulting from travel restrictions and lockdowns.

Financial stocks have also come under pressure as the MSCI ACWI Financial sector declined over 6% during the month due to a decline in longer-term interest rates. Financials, especially banking stocks, are sensitive to changes in longer term interest rates as banking profits are a function of the spread between short-term and long-term interest rates. The emergence of the Omicron variant and the possible threat that it poses, sent investors hurtling towards the safety of US Treasuries driving up their respective prices on increased demand. As a result, the yield on the longer-term 10-year US treasury fell due to the inverse relationship between the price and yield of bonds.

The one sector that did deliver a positive return for the month was the MSCI Information Technology sector having gained close to 3% during November. Technology stocks tend to benefit from low or falling interest rates as much of their value lies in the longer-term. A lower, longer-term interest rate means that the rate at which their future profits or cash flows are discounted is lower which in turn results in higher valuations for these stocks, at least in theory. However, the returns we saw for the sector during November were not broad-based and rather it was the performance of semiconductor companies that contributed to the sector’s strong performance. Rather than interest rates, a combination of strong corporate earnings as well as the fast-growing theme of the “Metaverse” drove the stock prices of these companies higher. Despite supply chain issues, especially in the auto industry, demand for semiconductors remains incredibly strong. Demand gained further momentum as Meta (formerly known as Facebook) announced its intention to rebrand itself as a metaverse company. The metaverse can be thought of as a series of persistently interconnected 3D rendered simulations or virtual worlds that interoperate with one another. One way of thinking about the metaverse is that it is the next evolution of the internet. The proliferation of mobile devices expanded upon the “hardened” desktop internet of the 1990’s and early 2000’s. Currently, the internet is composed of billions of webpages and devices and the metaverse will be the next iteration but moving from a flat 2D environment into an immersive 3D world. These “worlds” will of course require more processing power and therefore increased demand for semiconductors.

Prior to Omicron fears filtering through markets, global equities in general were on track to end the month in positive territory. A combination of companies reporting strong earnings as well as encouraging economic data had gone some way to propel equity markets higher. That said, one particular piece of economic information that continues to cause concern for markets is the level of inflation. US consumer price inflation has run at five percent or more for the past five months and in Europe, the United Kingdom saw inflation exceed expectations, rising above 4% whereas Germany recently saw its inflation level hit a near three-decade high.

As inflation levels remain elevated there is increased pressure for central banks to raise interest rates sooner than expected in a bid to put a lid on rising prices. The possibility of rate hikes in the US arriving sooner than expected has been strengthened by the reappointment of Jay Powell as chair of the Fed. The Fed has become increasingly hawkish (concerned about inflation) in its stance and his reappointment may signal that the Fed intends to remain focused on this issue. In fact, despite the threat that Omicron poses to economic growth, shortly after his reappointment, Powell has noted that he would consider accelerating the bond tapering process in a bid to reel in inflation. The prospect of sooner-than-expected rate hikes had seen the 10-year US Treasury yield creeping higher, almost reaching the 1.7% level. However, as already mentioned, fears surrounding the Omicron variant saw investors flock to safety in the form of US treasuries which in turn led to a fall in the yield of the 10-year US Treasury as it eventually ended the month  slightly above 1.4%.

Despite increased pressure on central banks to raise rates, the Bank of England surprised investors by keeping interest rates unchanged at 0.1%. The European Central Bank (“ECB”) also appears reluctant to raise rates despite rising inflation as ECB president Christine Lagarde has urged patience and to avoid tightening monetary policy prematurely. During November, European equity markets had already begun to waver on the news of a new wave of COVID-19 cases which led many European countries to implement strict lockdown measures. The emergence of the Omicron variant added fuel to the fire and the FTSE 100 and Euro STOXX 50, broad measures of UK and European equity markets, ended the month down by more than 2% and 4% respectively.

One equity market that did perform relatively better than its international counterparts was the local bourse. The JSE All Share Index gained over 4% during the month in local currency terms (in US dollar terms it only declined 1%). The local market was lifted higher by strong gains from luxury goods company Richemont as well as strong performances from gold miners such as Gold Fields, AngloGold Ashanti and Harmony Gold. Concern over hotter-than-expected inflation as well investors flocking to safe havens following news on the Omicron variant the likely factors behind the gains.

While the US and UK have held off from raising interest rates, South Africa has already begun the process as the South African Reserve Bank (“SARB”) monetary policy committee raised the repo rate by 25 basis points to 3.75%. During 2020, in an effort to provide monetary support, the SARB reduced the repo rate from a level of 6.5% to 3.5%. The recent rate hike signals that the SARB believes that economic growth remains on track, but it remains concerned about the level of inflation and its current trajectory. It is unlikely that a 25-basis points hike in itself is sufficient to stave off rising inflation, but it is likely that this may be the first in a number of rate hikes heading in our direction.

As we move towards the end of the year, once again markets have been gripped by fears surrounding COVID-19. There are however still a lot of unknowns surrounding the Omicron variant such as how infectious it will be, the level of serious hospitalisations it might cause, how effective existing vaccines will be against it and whether we will require booster shots or a new vaccine to combat the threat that it poses. Christmas and New Year’s Eve celebrations are likely to be a timid affair once again with turkey-for-two the main special. One can only hope that come next year December we are not discussing the effects of the Omega variant.