The Big Conversation
Episode 102: COVID fears shock the markets
This week we break down the equity and commodity market’s reactions to the discovery of the new Omicron variant of COVID. Equity volatility spiked late last week and has remained elevated this week as bipolar markets oscillate between sharp sell-offs and rallies. In The Chatter segment, Roger Hirst speaks with Refinitiv’s Darrenth Hawken about how the infrastructure mega theme is evolving, focusing on the balance between encouraging sustainable infrastructure for the future, while also giving enough attention to legacy infrastructure and technologies that are still vital to powering the economy through the energy transition.
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Max [00:00:00] Last week on The Big Conversation, we highlighted the effects a dollar surge could have on global markets. And although it's far too early to determine whether the surge in the dollar has played out, what the effects of that surge might be, another familiar factor has brought turmoil and volatility to a handful of asset classes. COVID resurgence fears. Markets sold off sharply in a shortened trading session last Friday as the world reacted to the announcement of Omicron, a new variant of COVID 19 emerging from Africa. South Africa sounded the alarm soon after they discovered the variant, and as such, not much is known other than the large number of mutations in this new variant. This uncertainty is exactly what we are seeing from governments around the world, but from markets as well. After nearly three months of trading below 20, the VIX rose to highs of 28 on Friday and maintained elevated levels through this week's early trading. Index prices mirrored this uncertainty, with a sharp rally on Monday following Friday's sell-off, and then yet another reversal and sell-off in early trading on Tuesday. Although this relative volatility was a shock to traders used to the slow grind higher over the previous two months, it's important to put these moves into perspective. We are still only down a few percent from recent all-time highs. This reaction is of course, related to the potential policy responses from governments around the world, which as well have been mixed. At least 69 countries have imposed travel restrictions, with some governments like China, Japan and Australia quick to immediately squash plans to reopen, while other countries limited travel restrictions only to the African countries where the variant has been developing. These restrictions are not without debate, as some data on how long the variant has been incubating suggests that as likely already made its way to countries with consistent travel to and from South Africa. On top of this, some countries like Germany have already recorded cases of Omicron in individuals with no foreign travel, confirming that it's already present in the population. Now, the market's playbook for lockdowns and travel restrictions from the initial COVID 19 outbreak is pretty clear, and we're seeing many of those same moves begin to play out this time, namely falling energy prices and trouble for reopening plays like airlines, cruises and hotels. Oil has come down almost 20 percent from its peak earlier in November. Now it's important to highlight, though, that this move began before COVID fears resurged, with the market reacting to Biden's focus on lowering oil prices and his decision to tap the U.S. Strategic Petroleum Reserve. But this move was kicked into overdrive at the end of last week, with crude oil trading limit down on the shortened Friday session. Now airline stocks and cruises as well are down, having followed a similar path to energy commodities. But what is interesting, though, about this COVID scare as compared to the initial outbreak in 2020, is that we aren't seeing the stay at home darlings rally. After a one day pop, stay at home favourite Zoom has at least in the short term, not provided the safe haven it did the last time around. If you're using work from home ETFs like WFH to track this theme, you might be thinking differently, with the fund up slightly over the last week. But a look at its holdings reveals a list of names far different from the work from home stocks that drew the most attention in 2020, and a portfolio filled with more established gig tech names than the work from home pure plays. Work from home stocks like Zoom and Grubhub rallied hard in 2020 on the narrative that lockdowns and shifts to remote work would benefit their bottom lines. But come 2021, when it was time to prove these narratives with revenue growth and earnings, these stocks faltered, leaving some investors holding the bag, and potentially leaving the market cautious to jump back into the narrative chasing game that dominated 2020. Another twist that needs to be considered this time around is what this means for important central bank policy decisions. The Fed announced in their November meeting that they would begin normalising policy. Starting first with tapering of their asset purchase programme and eventually looking to raise interest rates from their current levels. This decision was based on the robust economic recovery we had seen since they implemented these measures to combat the economic damage of COVID. But this course might be altered should the world again have to react to a winter resurgence of COVID. The problem with reversing course, and re-implemented protective policies is that this time around, inflation is a much different story, and it seems to be driven largely by supply chain issues. Although lockdowns may be a deflationary shock, it is likely to exacerbate the supply chain issues, causing the inflation that many argue central banks are already behind on fighting. At this moment in time, uncertainty is the name of the game as the world waits for clarity on what the Omicron variant has in store. But it is important to remember how uncertainty to the upside can play out. The knowledge level of scientists and policymakers as it relates to battling COVID 19 without disrupting the economy is at much higher levels than it was at the initial outbreak. And as of now, we don't actually know much more about Omicron and that is different than what we have seen before. Although the risk to the downside is serious, and this is what markets are currently pricing in, it is important not to forget how the emergence of effective treatments and a reversal of cautionary measures can send markets soaring higher, as we saw before. After focussing on short-term developments in the Big Conversation, we turned to one of the more dominant medium to long term themes of 2021. Infrastructure investment. In anticipation of the digital and energy transition megatrends, fiscal support may have fallen short of expectations, but private investment is accelerating. And in the chatter segment, Roger Hirst talks to Refinitiv's Darrenth Hawken talking about how these trends are developing.
Roger [00:05:59] Good morning or good afternoon, Darrenth. Good to see you. Infrastructure has been one of the biggest kind of stories, it's been in, it's been out, but it's obviously a very fundamental core of a lot of the big megatrends that are going on. What's really been the biggest trends that have been sort of witnessed over the last 12 months in this space?
Darren [00:06:17] Yeah, thanks for having me. Good to see you again, Roger. And I think in terms of infrastructure, it's been just a story of sustainability. It's been a story of climate change. It's been a story of governments coming together with financial markets to ensure that we keep to the one point five temperature warming for the world. And it's probably an interesting time because we're seeing a confluence of different, different issues coming together. The politicians, the financiers and the general public to to to make those decisions that really count.
Roger [00:06:53] So is there, over the last 12 months have there been any sort of real standout areas, because I guess in many ways the focus is obviously been on things like transition, et cetera. But you know, there's obviously communications networks that are being built. Is it really the sort of energy transition and the sort of carbon infrastructure that's been the drivers here? Or is it a lot of different trends, including particularly things like technology, which are all happening at the same time, are they all seeing investment or is there real focus on one area?
Darrenth [00:07:21] Well, I think the, if you look at the numbers today, the numbers are far and away, talk about power. The generation of green and sustainable power. But when of course, we think about green and sustainable power, some countries will be able to generate a lot of green and sustainable power, places like Norway, Australia, where they have natural advantages, but in other countries like Singapore, Hong Kong, smaller nations, landlocked perhaps, will not have that access. So I think power, yes, generation, but now we're talking about storage, so battery storage, and there now is this sort of talk of the internet of power. So this ability to transmit power from one place to another across continents seamlessly.
Roger [00:08:06] And are these changes taking place quickly enough? Because I think in some ways, what we've seen is that, you know, there's almost been this neglect of existing infrastructure, which is seen as being antiquated, as we're moving on to these sort of new developments and new technologies. But as we've seen, particularly the northern hemisphere over the last four or five months, there is almost a sort of there's been this brewing energy crisis, it has faded a little bit at the moment, although new Nord Stream is still not online. Is there a risk that we haven't moved quickly enough on the new technologies? We haven't replaced the old so actually, now we've got a little bit of a shortfall?
Darrenth [00:08:41] I think that's a very good point and I think the market is stuck in, stuck in a real problem there. So what we've got is essentially government saying all the right things. We've got banks lining up and investors lining up to finance these things. But you're talking about processes that take years to complete the constructions. Governments can do a great deal to speed that up. And as part of the widened infrastructure and jobs plan, there was the reintroduction of a single federal office who will rubber stamp, who will speed up all of that approval process to bring it in. But you know where you lack that consolidated government thinking, like in Northern Europe and in Western Europe as you're talking, I think we're going to see a lot of problems to bring these projects online.
Roger [00:09:32] And does that mean in some ways that what we need to do is still responsibly invest in existing infrastructures that we already have, which may be, you know, may be still dominated by, let's say, fossil fuels, but invest in a way where we're forcing the users of fossil fuel to become more efficient, more green, but not neglect them so that we see these things effectively fall by the wayside, and creating in many ways as many problems in transition as we potentially hope to solve over the long term by making the change all the way?
Darrenth [00:10:01] Yeah, absolutely. I mean, the market is signalling that well and truly. Look at the price of coal. Look at the price of oil, look at the price of gas. These prices are all trading at record highs, so the market is saying transition is underway, but you know, how many cars does Tesla create every year? I think quarter of a million, two hundred fifty thousand? I mean, there are thousands and millions and millions of cars that need replacing, and it's just not going to be done at, fast enough. And I think it's also worth noting that the likes of Shell and BP all the big hydrocarbon companies, they've exited some of their dirtier air producing assets. But who have they sold them to? They've sold them to private investors, they've sold them to private capital. And these guys are typically the sharpest people on the street and they see good returns. Most of these were being sold when oil was 30, 35 a barrel. Now it's like 80 85. Huge returns.
Roger [00:10:59] In terms of the Biden plans and the US packages, because obviously in the depths of the pandemic, it seemed like it was almost going to be infinite fiscal stimulus, and then obviously there's been a little bit of pushback from Manchin, and it feels like, you know what was going to be two and a half to three is going to be one and a half, but maybe it's brought forward. Do you feel that there's, maybe not been quite the size and the speed that people expected? Or do you think that it's still on track in terms of the fiscal packages, which ultimately are behind some of the real pushes towards these new infrastructure projects?
Darrenth [00:11:30] You know, the headline numbers are, have come down, but they still eye watering, right? I mean, they're they're enormous, and there was always going to be political compromise. Neither side had a clear mandate, there were, you know, conservative Democrats who were feeling pushed into a decision which they didn't really want to make. But also, when you look into the depths of the bill, particularly the Biden bill, it's actually called the Job Creation Act, and it's been kind of nicknamed the infrastructure bill. But there's a lot of detail in there as well, which will kind of confound the market. There's specific amounts which are called out for certain projects. So internet, broadband internet, electric buses, there's amounts allocated for all of that. Some people think some of those amounts are too high. Some are too small. Compromise, compromise,. How much flexibility? And the one thing that the market is kind of struggling with is that it wasn't the lack of money financing that stopped these projects, it was essentially all of the granular detail that these projects need to be completed to actually come on the line.
Roger [00:12:44] And one thing I guess where people, you know, there's obviously cynics in the space when it comes to the transition, particularly the energy transition. But where most people actually agree is, you know, investors want to make money and actually there are some fantastic opportunities for investors in the transition. What are the bits where you know everybody can really focus on? If you think about with our investment hats, which which are the areas within this transition are the ones that are standing out, which are happening now where people should be focussed because this is where the real action, the real momentum is already taking place and where we can actually join in and make make effectively some money?
Darrenth [00:13:15] Yeah, I think, you know, the personal choices that we can all make, both in the environment and financially pretty much rest in power. You know, I mean, you know, the way ahead is really the generation of that, that wind, that solar, offshore, onshore for the wind obviously, some countries will have a lead in that, the UK has done a very good job in installing a lot of offshore wind. But of course, sometimes the wind doesn't blow. And you know, that brings problems, which we saw in August of this year in the United Kingdom. But I think in terms of financial, financial benefits, it's very much there for each individual user now. And I think you're looking at a generation that are coming up, I'm in my mid 40s, but my children in their teens are very concerned about the environment. When they talk, I talk to my nieces and nephews, they're talking about the decisions that they're making, within their 20s, with their investable money, with their pension money, which is in the end where these assets will have to sit, they will have to be financed long term by the pension holders, they're going to make these ethical decisions, I think, much faster than some of the generations. So that that wall of money, that money coming into the sector will almost be like a volume knob turning up as we get that demographic come into the workforce, start putting money away for their retirement and making really strong decisions. One market where you're already seeing that very extensively is Australia. We have a very large superannuation market and they, they are heavily invested in the, in the infrastructure assets.
Roger [00:14:47] So it's a classic, follow the money. And are there any areas where you know, it's almost been a bit of a surprise in sort of, you know, when you look at maybe 12 months plus maybe actually, let's say five years where you think that, you know, people will be surprised at the speed that things are moving. Is it going to be energy or are there other areas within infrastructure where people may be surprised by the speed of things?
Darrenth [00:15:08] Well, I think energy is always going to get the, to get the focus right, and I think the next big tap potential is hydrogen. How to do that and to do it at scale, I think that's the most important thing. And I think that's probably more of a role where governments have to de-risk projects to kind of take the first loss in the project. A number of governments around the world, the UK being another one, who have kind of gone in with project sponsors to kind of provide some sort of incubator capital, if you like to get the whole project off the ground. But of course, through the process of creating hydrogen, you need power, you need electricity to create it. And of course, that has to come from green and sustainable sources as well, otherwise, you're sort of cancelling, cancelling one out. So I think hydrogen is going to be a big part of the future, and that is the power story. But I think as well urbanisation, digital cities, the creation of a much more incorporated living space for us, particularly if this sort of you know, homeworking model goes forward more on a global basis. I think you're going to be looking at people living in different structures. And I think the infrastructure that you're seeing laid out in some countries like Saudi are really laying the cornerstone for some of those cities of the future.
Roger [00:16:30] So, so overall, it's pretty, pretty dynamic. It's still all on track, there's a few obviously there's a few things we are going to be watching for, but ultimately, I mean, this is, it is one of the megatrends that's going to continue for decades.
Darrenth [00:16:43] Yeah, off the back of COP I think, you know, there was a whole section on sustainable infrastructure, which I think is where you're going to see the narrative move, from infrastructure to sustainable infrastructure. So, you know, ports and railways and airports will all be kind of considered old and dirty. Perhaps now, in the same way, that LNG is now considered a bit old and dirty, and you will just see this go on and on and on. I don't actually see it stopping for the next you know 50 years.
Roger [00:17:12] Brilliant. Well, thank you very much. Great stuff. Great to hear, get the updates, see where we're going, and thanks very much for your time.
Darrenth [00:17:19] Thank you. Thanks for having me.
Max [00:17:20] The energy transition has dominated the infrastructure discussion, but the energy crisis in the northern hemisphere has also highlighted the dangers of underinvestment in existing infrastructure. Transition is rarely smooth, but there are some great opportunities within this sector. Investors can monitor global developments via Refinitiv's Infrastructure 360 app, which focuses, amongst other things, on trends, risks and the funding of global infrastructure projects.