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Wall Street flirts with the Grinch, rebounds to a jolly rally

With studies hinting that the coronavirus omicron variant is far more communicable but also substantially less deadly than the delta strain, investors first pulled back and then recouped early-week losses.

MANHATTAN (CN) — Investors avoided a blue Christmas after a rocky start to the week, buoyed by promising data on the omicron strain of coronavirus.

Fears over omicron's rapid spread caused the initial rout. Investors regained their footing, however, amid news from Pfizer that its recently approved experimental treatment is effective against the variant, combined with British studies suggesting Covid-19 infections caused by the variant are less deadly than those wrought by delta.

Investors have latched onto the prediction omicron will likely be short-lived and result in fewer deaths than the delta wave. “As such, omicron may cause temporary disruptions in high-frequency economic data and some corporate earnings, but it’s very unlikely to be a sustainable headwind that derails the rally,” Tom Essaye of the Sevens Report wrote.

So far Wall Street’s resilience has proved itself. Wall Street posted large losses early in the week, but by the end of the trading on Thursday it reclaimed those declines and then some. The Dow Jones Industrial Average, which had lost about 400 points on Monday, finished the week up 585 points, while the S&P 500 and Nasdaq took similar a track, gaining 105 points and 484 points, respectively. Markets are closed on Friday for Christmas Eve.

The omicron strain of SARS-CoV-2 has quickly become the dominant version in the United States, with some models predicting 140 million new infections due to it. As a result, European countries are reinstating various kinds of lockdowns while President Biden has ordered 500 million more home tests to help curtail the spread.

Wall Street was initially dismayed by the new strain then grew less nervous about its spread, with markets rallying back in recent days.

Despite Wall Street skirting disaster with omicron this week, equities are “priced for relative perfection but is still facing a more hawkish Fed and continued high inflation,” Essaye wrote. He added that, barring a surprise deal on the Build Back Better legislation or a suddenly dovish Federal Reserve, “it’s tough to see what can sustain a rally in stocks right now much above 4,700 in the S&P 500.”

Inflationary concerns have taken a back seat in headlines to the virus, but not in the minds of investors.

Some experts, such as Simon MacAdam, senior global economist at Capital Economics, say 2022 will still be dominated by inflation. “If omicron further disrupts already stretched supply chains, goods inflation could be higher than we are forecasting, keeping overall inflation higher for longer,” he told investors in a note. “By 2023, most of the factors dragging on headline rates will have run their course, and goods inflation should ease as shortages improve.”

MacAdam noted that, while headline inflation should drop in 2023, core inflation will likely settle at 3% above what the Fed had predicted.

Even if the virus recedes and takes supply chain disruptions with it, some say inflation will not pull back to pre-Covid levels. “Companies will be spending at least 2022 and likely 2023 trying to recapture the lost margins due to their spike in costs,” said Peter Boockvar, chief investment officer at Bleakley Advisory Group. “They will essentially piecemeal out price increases in some form.”

Despite the lingering virus and inflation concerns, consumers have pivoted to embrace some holiday cheer.

The latest survey from the University of Michigan showed that consumers’ sentiment this month inched forward to 70.6 points after taking a dip to 67.4 points in November, though it is still down 12.5% year over year when the survey showed consumer sentiment was at 80.7 points. Inflation remains a predominant concern, however, with 27% of households saying inflation has lowered their living standards, the highest percentage saying that in nine years.

“The best news was the anticipated growth in incomes among households in the bottom third of the distribution,” survey economist Richard Curtin said. “Unfortunately, the extremely regressive nature of inflation has also meant that even these gains will leave these households without inflation-adjusted income gains.”

He added that, while it is too early to predict the full impact omicron will have on pricing and employment, it is “likely to continue to put upward pressure on prices as well as weaken the pace of economic growth.”

The consumer confidence index by the Conference Board also increased a few points to hit 115.8 points — better than what experts had forecast. Ataman Ozyildirim, senior director of economic research at the board, said that inflation and supply chain disruptions remain concerns but that the risks from them may be contained. He forecasts gross domestic product growth to strengthen during this quarter.

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