Goldman rethinks OMICRON bullishness

Goldman with the note. This is a day old so many of metrics have deteriorated. The MBFund is nicely positioned to buy if this gets nasty:

Omicron drives sharp decline in Risk Appetite

Last week newsflow around the Omicron COVID-19 variant weighed on risky assets, overshadowing generally positive macro data on both sides of the Atlantic (European flash PMIs and US consumer sentiment rebounded more than expected). The ‘risk off’ at the end of the week was very sharp, likely exacerbated by positioning and illiquidity around the Thanksgiving holiday – Friday was one of the days with the largest number of assets recording a >2SD move since the late 1990s (Exhibit 1). Dissecting the price reaction of a number of pro-cyclical assets Friday reveals a large COVID-19 growth sell-off (Exhibit 2): Re-opening trades such as Airlines and the GS Recovery vs. Stay at Home Baskets were among the worst-performing assets in SD terms. Credit spreads, which have been relatively resilient to equity volatility for most of this year, have widened sharply. The Dollar has been the least correlated to risky assets, although it weakened vs. the Euro.

Given the speed of the growth re-pricing, our Risk Appetite Indicator (RAI) fell sharply into negative territory on Friday due to worsening growth sentiment (RAI PC1) (Exhibit 3).

Looking at the RAI subcomponents by asset class shows that a sharp rise in equity volatility and widening credit spreads, after a period of low volatility, drove most of the RAI decline. A more negative RAI usually suggests a better asymmetry to add procyclical risk. From current levels around -1, the signal, if not supported by a better, less uncertain macro backdrop, is not that strong yet. Hit ratios for positive S&P 500 returns tend to increase as the RAI approaches -1.5 (Exhibit 4).

Growth uncertainty might linger near term, and it comes at a time when investors have to digest high and sticky inflation and monetary policy tightening. Our economists have estimated a downside scenario in which global growth in Q1 could slow to a 2% quarter-on-quarter annual rate, 2½pp below our current forecast, and would accelerate in the summer above our current forecasts. A continued ‘risk off’ in the near term should create better asymmetry to add risk – support could come from relief around the severity of Omicron or if central banks turn less hawkish. While the VIX spiked above 28 on Friday from low levels, it has started to decline today and did not increase much further out, suggesting markets are not extrapolating current volatility (Exhibit 5). To hedge correction risk in the near term, we like put spreads or payer spreads in credit – credit volatility appears attractive vs equity, especially as credit has become more volatile (Exhibit 6).

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