What would another lockdown mean for markets?

Markets are decidedly not full of the Friday feeling today.

Markets are tumbling as we’re all hearing about yet another variant of Covid-19, which has resulted in England putting South Africa on the red list.

So what’s going on?

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Markets are clearly rattled by the new Covid variant

The first thing to remember about markets today is that yesterday was Thanksgiving in America, so the country is shut as it sleeps off a surfeit of candied yams, which in turn means that there are a lot fewer people in the market, and that tends to mean more exaggerated moves.

So with that caveat in mind, markets have sold off quite viciously this morning, with equities and oil in particular hit hard.

Why? Just by glancing down the list of fallers it’s very clear what’s happened: everyone is suddenly worried about what appears to be a particularly virulent new strain of Covid.

IAG (owner of British Airways) was down by 16% at one point in early trade, while oil companies took a hit too, as did the oil price. In short, this is a “what if we have to lock down again?” panic move.

Given that the travel companies in particular were just hoping they might be able to get back to something approaching normal in 2022, it’s no surprise they’ve been hit so hard.

When it comes to epidemiology, I’m not an expert. Indeed, I would go so far as to describe myself as not even approaching being an amateur, so I have no idea how big a deal this new variant is one way or the other. I don’t plan to pontificate on that side of things.

But given that many countries in Europe were tightening up again even before this particular variant popped up in today’s headlines, it’s worth having a think about what more lockdowns or disruption might mean for markets.

There are a lot of variables affecting markets right now. But the main ones in the last few months have been inflation and interest rates.

Investors have been concerned that rising inflation will push central banks to raise interest rates more rapidly than they’d expected. Beyond that though, investors have rather seemed to assume that the strong economic recovery would continue.

You can understand why. Demand has been high, jobs have been plentiful, and while the underlying financial picture isn’t necessarily terribly healthy (too much debt, as ever), the main risk was that central banks would feel forced to raise rates sharply enough to tip it all over.

What would repeat lockdowns mean for your portfolio?

But now we have the spectre of a repeat shutdown. What would that mean?

Any further lockdowns push back the prospect of getting back to “normal” which is bad news for the “reopening” trade. So you get a sell off in travel stocks and all the other stuff that’s cyclical and dependent on the economy returning to work.

Beyond that, the market reaction mostly boils down to what this all means for rates and for inflation. That’s where this differs from the previous lockdowns.

On the one hand, more lockdowns would mean that central banks almost certainly would stop any efforts to raise interest rates. On the other hand, further lockdowns would throw even more disruption into an already-disrupted market, which implies more inflationary pressure (particularly if it gets to the stage where governments feel they need to add more stimulus).

Again, you can see this pretty clearly from the market reaction. Gold has rebounded from its recent dip (which is a bet by investors that inflation will go up or interest rates won’t move, or both), while the tech-heavy Nasdaq has sold off less than the other markets (because it’s home to a lot of stay-at-home stocks and stocks that particularly like low interest rates).

So we know what the thinking is behind these market reactions. What should you do in terms of your own investments?

I don’t know if we’re going to get another big lockdown. I hope we don’t, but let’s say we do – it’s stating the obvious, but at some point it’ll be over again. At that point, most of these stocks are likely to recover.

I’m not suggesting you should buy anything specific if you haven’t already done your research and they’re on your watchlist, but I do think it’s quite possibly a good opportunity to get into the “value” trade if you haven’t already done so.

I’d also be a buyer of the dips in oil. Oil producers are already not keen to spend money on doing any more exploration; further lockdowns and drops in the oil price will not encourage that situation to change.

So, one way or the other, the medium-to-longer-run outlook is for higher prices. Either this turns out to be a scare and things rally anyway, or it’s not a scare, things get worse, and then they go back up again because when the recovery bit returns.

This is also a useful reminder of why it’s good to have some excess cash in your portfolio, and a watchlist already prepared, so that if investments you like go on sale, you’re ready and calm enough to buy if you feel the opportunity is appealing.

We’ll be keeping you up to date on all of this – and our 2022 outlooks – in the upcoming issues of MoneyWeek magazine. If you’re not already a subscriber, sign up to get your first six issues free now.