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We Can’t Blame Stock Market Volatility on COVID-19 Anymore

10 minute read

The market cares less about COVID-19 than you think. The recent volatility in global financial markets may seem like the latest pandemic-induced shocks, but there are signs that investors are growing accustomed to the idea that some form of the virus is part of our new norm.

The market has moved on to other, more pressing concerns, say many investment professionals. At the beginning of the pandemic, investors fixated on the virus’ every move. They poured over data on company lockdowns and vaccine advancements to assess how well individual companies were strategically positioned to profit. The resulting calculations sorted the business world into neat categories of winners–like Peloton–and losers–such as cruise ship operators. But over the past 22 months, the market’s herd mentality has evolved into a herd immunity of sorts. As a result, Wall Street’s worldview is now what finance strategists call an “endemic”—rather than “pandemic”—mindset.

Proof of this shift lies in the Chicago Board Options Exchange’s volatility index, known as the VIX, a wonkish metric that professionals use to gauge stability 30 days into the future. The VIX tracks the S&P 500’s basket of stocks and measures trends in options trading to estimate the likelihood of bumpy trading ahead. The higher the VIX, the more investment managers brace for high volatility, possibly holding off on big trades, or hunkering down for a rough ride; a lower VIX figure indicates that trading will be relatively in line with normal conditions.

Typically, the VIX fluctuates between low volatility marks of 10 and 20, with an occasional leap. The index skyrocketed at the end of March 2020 to near record levels above the 50s threshold. For context, the previous peak, of 59, came– you guessed it –at the end of October 2008 during the global financial crisis. That said, VIX levels were back down to the 20s come summer. They rose sharply as the virus surged in the winter of 2020, but got no higher than the low 30s in January 2021. Since then, the S&P had settled into levels in the 20s until ticking up to just over 30 on Tuesday.

In other words, following the pandemonium COVID-19 triggered when it first swept the nation almost two years ago, the VIX has telegraphed signs that the market is gradually becoming less reactive and more rational – moving from a fixation on short-term pandemic beneficiaries and setbacks to acceptance that the virus has become a more manageable phenomenon.

This is to be expected given historical trends, says institutional investor Randall Eley, head of the Edgar Lomax Company. “In the long-term, markets are a gauge of what people – and investors—really believe, instead of a measure of emotional reactions.”

“When you look at the 1918 flu, for instance, it was a shock to the system when the U.S. markets first realized what was going on,” Eley says. “Later, even though the pandemic was not over, the markets began to take it in stride, namely that this was not the Black Plague, and that the human species was here and would keep growing. Once that happened, investors kept advancing money to organizations that feed, provide and continue to be profitable.”

Explaining 2022’s downturn

That leaves the question of what’s triggering the stock market’s slide since the beginning of the year. The S&P 500 index has dipped 7%. Observers attribute that to a short list:

  • Inflation. The prospect that at current levels (about 7% per annum), galloping prices have the stock market fearing several things. One is that a significant amount of money will get vacuumed out of the stock market as the Fed raises rates and investors seek higher guaranteed returns in bonds.
  • A long upward climb that left stocks overvalued. Remember the old adage that trees cannot grow through the stratosphere? Well, stocks have sidestepped a bear market – a 20% or greater drop – since 2008.
  • In the past weeks, the threat of a significant war – Russia’s invasion of Ukraine – has set the market on edge.
  • What about Omicron? Market-watchers say it ranks a distant fourth.

    Any recap of the broad market’s path back from COVID-19 fright retraces the tale of two years: 2020 and 2021. The S&P 500 whipsawed in 2020, ending up about 15% after falling almost 20% in the first quarter. The next year, 2021, saw a steady stair-step to a full year gain of 27%.

    “Each new variant has had a lesser impact on mobility, so these trends will continue but to a smaller degree,” says Saira Malik, Nuveen’s Chief Investment Officer of Global Equities.

    Stocks that weathered the COVID-19 storm

    The market’s gradual trek back to “normal” featured a host of winners and losers during up- and down-phases of the pandemic. COVID-19 case numbers compiled by the CDC show three distinct periods up to the start of 2022. Surges took place during the initial crisis (March 20, 2020, to January 1, 2021), the rise of Delta variant cases (June 30 to August 31, 2021) and the latest Omicron-influenced upswing beginning November 1. Two marked downturns in new case numbers are also apparent: January 1 to June 30, 2021, and September 1 to October 31, 2021.

    A close look at stock sectors that did best during COVID-19 case surges and those that excelled during periods in which COVID-19 receded reveal a distinct pattern. Many of the companies whose stocks performed best during those times are in sectors that directly benefited from pandemic-triggered disruptions such as social distancing, remote commerce and working from home. Others were potential bargains in categories like energy and real estate that had been oversold.

    It’s no secret that a select handful of seemingly bulletproof stocks continued to rise undeterred by

    COVID-19 case numbers. These included the so-called FAANG stocks (Facebook/Meta, Apple, Amazon, Netflix, and Google/Alphabet) in addition to Microsoft and Tesla, all of which made up a surprisingly large portion of the stock market’s returns in 2020, and to a lesser degree, 2021.

    Sectors that did notably well during the three combined COVID-19 surges in 2020-2021 were the Information Technology, Materials, and Consumer Discretionary groups. “These sectors have benefitted from structural growth trends that have accelerated due to the pandemic such as digitization and technology, or else had increases in demand due to consumer behavior and lower input prices,” says Nuveen’s Malik.

    The Consumer Discretionary category is an interesting case. David Sekera, the chief market strategist of the investment research firm Morningstar, says Tesla, which S&P positions in the group, contributed to the group’s good performance. Peel down a layer, however, and there’s a slightly different story: “Another part of consumer discretionary move is anchored in the stay-at-home and economic normalization,” Sekera says. “Early pandemic, anything to do with people moving, working from home, furnishing home offices and remodeling projects while spending more time at home benefited Home Depot and the Lowe’s,” Sekera says now the spotlight is on retailers–including Home Depot and Target–that have committed to a multi-channel approach combining physical locations with mobile or remove platforms.

    The Materials group–exemplified by companies like Freeport-McMoRan and Air Products–was weakened in the early months of 2020, but bounced back and has more recently received a boost in anticipation of the first Biden infrastructure bill.

    Then there are the sectors that gained the most during periods in which new case numbers dropped: real estate, financials, and energy. “These sectors are cyclically geared to economic growth and will fare better when pandemic surges are not negatively impacting mobility and the economy,” says Malik.

    Stocks of companies in the Energy group, such as ExxonMobil, Chevron and ConocoPhillips, rebounded as global demand recovered after initial lockdowns early during the pandemic and inventory overstock was worked off. Financial stocks got a boost as massive stimulus injections stemmed an economic downturn and loan write-offs, and reserves came down. Examples include JP Morgan Chase, Band of America and Wells Fargo.

    Real estate shares, like those of Crown Castle, Prologis and Simon Property, were particularly sensitive to early pandemic concerns. “The group has had a good rebound after taking a hit early on,” says Morningstar’s Sekera. “Part of that lies in the fact that investors were concerned about malls and in-store shopping for a long period,” he adds. “The other part lies in uncertainty about office real estate, especially in urban areas with people working from home. We are starting to see that there is still definitely a need for office space and that a hybrid model is starting to catch on.”

    Perhaps the strongest proof that the market is no longer led by COVID-19 concerns can be found in what happened to the elite large capitalization stocks that sailed through the crisis unscathed.

    Sharp FAANGs

    Morningstar research shows how far the elite FAANG group—whose members boast jumbo market capitalizations ranging from $250 billion to Apple’s $3 trillion—skewed stock market returns. In 2020, for instance, Morningstar calculates that the five largest stocks – including Apple, Microsoft, Amazon, Facebook and Tesla – provided a massive 37% of the market’s return. While that number decreased in 2021 up to mid-November, to 8%, the market was still heavily skewed as evidenced by the fact that 20% of its return to that date was derived from the 10 largest stocks. For comparison, the long-term adjusted averages is 3% from the top five largest stocks, and 5% for the top 10.

    Where does that leave us at the start of 2022? Even as Omicron cases skyrocket, the market seems inclined to follow long-term historical trends – particularly by moving to undervalued sectors that have lagged. The reason: A 27% gain by the S&P 500 in 2021 leaves the overall market looking somewhat frothy. That, combined with higher levels of inflation, makes value stocks–typically companies whose stocks trade at lower metrics like price-to-earnings, price-to-book value, or price-to-sales ratios compared with the broad market –more attractive.

    Then, there are the sectors that did well when COVID-19 waned – Energy, Financials, and Real Estate.“Our view is that company-specific fundamentals will have a greater impact on these sectors rather than macro-economic drivers such as the pandemic,” says Nuveen’s Malik.

    A handful of sectors seem poised to benefit as more investors adopt an “endemic” mindset. Materials stocks will continue to benefit not only from infrastructure spending, but also due to other, the use of specialty chemicals in electric car and semiconductor manufacturing. In addition, the price of one of the sector’s key inputs –oil– tends to decline during COVID-19 surges.

    Pricing power, Malik points out, will be an important factor for companies in 2022. That gives many of the FAANG behemoths an edge, as many of the group’s biggest companies – Amazon, Meta and Alphabet – are shielded by services or products that are unique in markets where competition is less rigorous, or ‘wide moats’ as Morningstar puts it.

    A couple of interesting value sectors including banks and oil could enjoy tail winds as well. That’s especially true given the Federal Reserve’s decision to raise interest rates steadily over the next two years. “That’s an environment that bodes well for value stocks – companies with strong balance sheets,” says Edgar Lomax’s Eley. The financial and energy sectors fit that profile. While another sector, healthcare, may not have led the market during the last two years, it could be poised for an upswing. “Companies in that part of the economy are profitable, priced at low ratios to earnings and pay high dividends,” Eley says.

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