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The 3 Biggest Market Risks In 2022

The 3 Biggest Market Risks In 2022

With the current trading year drawing to a close, the experts are already making forecasts about the coming year largely based on the trends that have defined the current year. However, unlike in previous years, analysts are acutely aware that the Covid years have been littered with predictions that never panned out, with the pandemic triggering some serious market idiosyncrasies.

For starters, Goldman Sachs points out that equity market breadth has narrowed sharply, with just five stocks accounting for 51% of the S&P 500’s return since the end of April.

In fact, Microsoft (NASDAQ:MSFT), Alphabet (NASDAQ:GOOG) (NASDAQ:GOOGL), Apple (NASDAQ:AAPL), Nvidia (NASDAQ:NVDA) and Tesla (NASDAQ:TSLA) have accounted for more than one third (920 bp) of the S&P 500’s 26% YTD return. "After contributing over double their starting weight to the index’s return, these stocks now make up 22% of the S&P 500 by market cap, a 4 pp increase from the start of the year," David Kostin, chief U.S. equity strategist and team has written in a note.

Kostin says that following a period of similar market breadth "equities have historically exhibited weaker-than average returns and deeper drawdowns, but it has historically taken 4 additional months before a sustained increase in breadth takes hold and market leadership flips towards the previous laggards. Record index concentration is both a cause and a symptom of a narrow market."

Nevertheless, Goldman says that it's unlikely there will be a near-term recession with earnings and margins still improving. GS recommends owning high growth, high margin stocks, which have not only outperformed in recent months but are also likely to continue doing so in the coming year.

Bearing this in mind, Bloomberg Economics has laid out several risk factors that could threaten the ongoing bullish thesis. Here are the most egregious.

#1. Omicron and More Lockdowns

Last week, the World Health Organization (WHO) warned  that the Omicron coronavirus variant carried a very high risk of infection surges, with border closures by more countries now casting a shadow over an economic recovery from the two-year pandemic.

But the markets appear to be more spooked by comments by Moderna chief executive Stéphane Bancel who warned that existing vaccines will be much less effective at tackling Omicron than earlier strains of coronavirus, adding that it would take months before pharmaceutical companies could manufacture Omicron-specific vaccines at scale. 

“There is no world, I think, where [the effectiveness] is the same level . . . we had with [the] Delta [variant]. I think it’s going to be a material drop. I just don’t know how much because we need to wait for the data. But all the scientists I’ve talked to . . . are like, ‘This is not going to be good’,”  Bancel has told the Financial Times.

Bancel says scientists are particularly worried because 32 of the 50 mutations in the Omicron variant are on the spike protein, which current vaccines focus on to boost the human body’s immune system to combat Covid. Most experts did not expect such a highly mutated variant to emerge in less than a year or two.

Not everybody agrees with Bancel, though.

The Moderna chief’s comments have come at a time when many public health experts and politicians have been trying to strike a more upbeat tone about existing vaccines’ capacity to protect against Omicron.

On Monday, Scott Gottlieb, a director of Pfizer and a former  US Food and Drug Administration (FDA), told CNBC: “There’s a reasonable degree of confidence in vaccine circles that [with] at least three doses . . . the patient is going to have fairly good protection against this variant.” 

Moderna and Pfizer have become the leading vaccine suppliers for most of the developed world. 

More encouragingly, it’s early days into the Omicron era but so far, most cases have been relatively mild. In fact, WHO has pointed out this observation, and urged countries to apply "an evidence-informed and risk-based approach" to travel measures instead of resorting to blanket bans.

At this juncture, it’s too early for a definite verdict on the omicron variant of Covid-19. A more contagious and deadly variant would definitely drag on economies, with even a three-month return to the toughest 2021 restrictions slowing down growth considerably.

In such a scenario, demand would be weaker and the world’s supply problems would likely persist, with workers kept out of labor markets and further logistics snarl-ups. Already this month, the Chinese city of Ningbo--home to one of the world’s busiest ports--has seen fresh lockdowns.

#2. The Inflation Threat

At the beginning of the current year, the market consensus was that the U.S. would end the year with 2% inflation. Instead, that number is now closing on 7%

In 2022, once again, the consensus expects inflation to end the year close to target levels. We cannot exactly rule out another awful miss.

Omicron is just one of the several potential threats; rising commodity prices, supply chain disruptions, worsening tensions between Russia and Ukraine and worsening climate change could easily throw a wrench into the works.

 The combined impact of these threats could trigger a stagflationary shock to the markets.

#3. China Hits a Great Wall

After several near-misses, China’s economy finally ground to a halt in the third quarter thanks to the accumulated weight of the Evergrande real estate slump, repeated Covid lockdowns and energy shortages. The Middle Kingdom only managed to eke out a 0.8% growth clip in the quarter, a far cry from the  6% pace to which the world has become accustomed.

The worrying fact is that whereas the energy crunch is likely to ease in the coming year, there’s no end in sight for the other two problems. Beijing has adopted a zero-tolerance policy for the pandemic, meaning any new breakouts are likely to lead to further lockdowns. Bloomberg Economics’ base case is for China to grow 5.7% in 2022; a slowdown to 3% would be enough to send ripples across the globe, leaving commodity exporters short of buyers and potentially derailing the Fed’s plans.

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