Black Friday was actually black (and bleak?) for once this year as a new and seemingly very transmissible variant of the Covid-19 coronavirus rocked markets.

Both volatility and declining markets has only continued since. Here is the S&P 500 since the ill-fated arrival of Omicron:

As with a lot of Covid-related coverage there has been a lot of pretty wild speculation where the amount of commentary is directly inverse to the amount of hard information and scientific clarity.

We have zero scientific edge on the new variant and whether its greater transmissibility will lead to:

1. A new wave of severe 2020-style lockdowns or

2. More tragically, a higher mortality rate.

But we hope - as do we all? - that the death rate will remain low even as the transmission rate likely rises.

And it is possible that a MORE transmissible disease that is LESS deadly could crowd out other variants and would be an all around BETTER situation.

Disagree? Please write us at contact@pebble.finance with your thoughts.

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For now, while the situation is still very foggy, it isn't clear whether new lockdowns - or travel bans - are really the answer either. The 2020 Covid playbook may have been necessary but it was also certainly clumsy and inefficient and in an era where:

1. We know a lot more,

2. Treatment has improved significantly and

3. Most importantly, we have highly effective and flexible vaccines.

It isn't clear that hammering down a global economy will be either medically effective or politically tolerable.

And it is undoubtedly true that most of the world is not yet vaccinated and the West is doing a lamentable job of ensuring access and equitable distribution of vaccines to poorer countries.

Taken together, it does seem that the level of fear and even panic may be somewhat exaggerated. Here is the CNN Fear and Greed Index which is constructed from 7 different market indicators.

At the time of writing we are at 25 or "Extreme Fear" per their specifications. This has been a RAPID shift from the opposite extreme less than two weeks ago:

However, the rise of Omicron has accomplished one "big" thing which is to change and challenge the expected path for the Federal Reserve.

We have repeated again and again that the Fed's determination of inflation and also its approach to removing the exceptional level of monetary stimulus will be critical in deciding the path forward for many asset prices.

And this is what happened after the WHO's Black Friday announcement of Omicron as a "variant of concern:"

Fed rate hike expectations have been pushed out.

The market has shifted to expect easier monetary policy and one of next year's hikes has already been "lost" as markets digest the Omicron hit to growth and reopening.

This still might be the case but here is the challenge with this view:

Trimmed Mean PCE inflation from the Dallas (and a Chair Jay Powell favorite for determining whether the Fed is "meeting" its inflation mandate of 2%) continues to accelerate higher.

This puts the US central bank (and therefore the markets) in a bind:

They have to deal with the inflation to stay within their mandate but are now also confronted with a new and very uncertain threat to economic growth. Market participants have quickly realized that, unlike much of the last decade, the central bank would likely pick the former rather than protect the latter.

Sure enough, Chair Jay Powell, newly re-appointed to his role and testifying before Congress, confidently suggested that the word "transitory" should be retired and that the taper would, in fact, be accelerated in 2022 Omicron or no Omicron.

This was tough talk for investors to hear but perhaps Chair Powell agrees with the assessment that the Omicron will hopefully not prove to be as bad as last week's reaction suggests.

The American people might agree with him.

An Arbor Research analysis of Google search terms by American consumers suggests that, at least so far, Americans are not returning to the searches of severe lockdown like activities:

​And preliminary data from South Africa show that - so far - deaths are not rising with transmissions.

That is great news!

But regardless of whether Omicron proves deadly or not, suddenly investors are faced with a potentially very different set of economic conditions as we move towards 2022:

1. A (still) lingering pandemic that crimps growth.

2. Financial conditions set to tighten on Wall Street

3. A more hawkish Fed removing monetary stimulus and, eventually, raising interest rates

4. Fiscal policy (e.g.: higher state transfers) set to slow.

5. And slowing earnings growth from companies.

Coming to this realization has been unpleasant for investors looking to close out a strong year. When this paradigm encountered very illiquid market conditions it accelerated the recent volatility and created some exaggerated, vicious moves.

The upshot is that volatility now begets volatility and it isn't clear that the Fed has investors' backs anymore. They may choose to fight inflation rather than support growth. The December FOMC 15th meeting may not bring the type of relief investors have learned to expect.

Add it all up and it seems like December could be rough for small and large investors alike:

Frequently, stocks rise roughly into year end as funds try and lever up and outperform in the final trading weeks of the year. Now, the risk is that rather than the usual "Santa Claus rally" you instead get the very opposite. Investors will either try and protect gains by selling winners or harvesting tax losses by selling losers.

This would be unpleasant.

Away from the short term volatility and painful market gyrations, it is important to keep your eye on economic growth in 2022 and how the Fed threads the needle between regaining credibility on inflation while also not pushing the economy over a cliff.

As long as economic growth stays intact then financial markets should respond but the risks are far more balanced than they have been since the early months of Covid uncertainty.

And speaking of volatility and exogenous shocks, another wintry crisis continues to accelerate in Europe.

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