Markets aren’t pricing in mutation risk

By Larissa Fernand |  26-07-21 | 
 
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About the Author
Larissa Fernand is Senior Editor at Morningstar.in. Follow her on Twitter @larissafernand

A few months ago, a JP Morgan survey revealed that about 29% of investors view COVID-19 variants as the greatest risk to markets. Later, a survey in the U.K. revealed the same fear: new strains of the virus and an uneven global vaccine campaign were viewed as the greatest risks to market stability.

The European Central Bank’s President Christine Lagarde also voiced concerns on this front. “The nascent recovery faces uncertainty due to the spread of virus mutations, though the improved economic outlook on the back of rapid progress in vaccination campaigns has reduced the probability of severe scenarios,” is what she recently stated in the European Parliament.

What does this really mean?

As a virus replicates, it undergoes genetic mutations that may create what are called variants. Some mutations weaken the virus; others may yield an advantage that enables it to proliferate. If changes produce a version with distinctly different physical characteristics, the variant may be co-termed a strain. Right now, the variants of COVID-19 are Alpha, Beta, Gamma, Delta, Kappa and Lambda.

One person worried is Magellan's chairman, CIO and lead portfolio manager, Hamish Douglass.

In a note, he stated that, “we need to be cautious until clearer facts emerge on the mutation risk of the virus. There is no margin for error in markets to account for this risk. We have no idea if an escape mutant will emerge. But we know this risk is foreseeable. You need to add to this risk the complexity of the macroeconomic environment driven by the massive monetary and fiscal stimulus that is being deployed and also the rising risk from emerging speculative bubbles.”

Emma Rapaport from Morningstar Australia shares his views from a digital event. 

We are not over [the virus]. We were all going to the football and the pub. We all thought this was over. The risk is we get an escaped mutant from this virus, one that evades the vaccines. We've seen so many mutations happening this Delta one's frightening and the speed it can spread.

The vaccines still seem to be effective against death, but that might not always be the case.

They're (Emerging Markets) particularly vulnerable with what's going on in the pandemic and we could really see a market correction.

Markets aren’t pricing in mutation risk because of the recorded effectiveness of the vaccine against death. But the risks are real and foreseeable.

I'm not saying it's gonna happen. Actually I've no idea where it's going to happen, but the probabilities of [an escaped mutation] happening are increasing by the day.

Are we about to have a material market correction? The answer if I'm very honest with you is, I don't know. It's just really hard to judge what's going to happen there. You could bet in either direction.

You have to have a very balanced approach here knowing that the markets could continue to be strong, but there's major risk out there. I think you want to be somewhat conservative here if some of the downside events happen.

Douglass's advice for investors: This isn't the time to get overconfident.

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