Omicron triggers panic

‍Chart of the Week

Investors are driven by two emotions: fear and greed. Too much fear can cause stock prices to fall far below the value they should have (and a strong market rebound may soon follow). When investors become greedy, they can drive stock prices far too high (and a crash may be near).

Why this matters:

Within just one week, the index dropped from 69 (greed) to 31 (fear). Such a rapid shift is rare. In a long-term comparison, such a strong change in investor sentiment is usually followed by a strong counterreaction. Everything suggests that last week’s market turmoil led to a significant overreaction and that the markets are likely to recover.

Omicron triggers panic

At first glance, the chart is indeed quite concerning. The variant appears to be far more contagious. However, the data is based on very limited numbers. In addition, the variant emerged in regions that previously had relatively few infections and low vaccination rates. Whether Omicron will spread just as strongly in the United States or Europe—where it faces strong competition from other variants and many people are vaccinated—remains to be seen.

In addition, governments in industrialized countries have become more experienced after 1.5 years of COVID and will look for ways to ensure isolation measures while avoiding a complete shutdown of the economy. And not to be forgotten is the helping hand of central banks.

Based on these considerations, institutional investors are also beginning to build up their market positions:

The Smart Money Flow Index (SMFI) is based on the idea of the Smart Money Index (SMI) by Don Hays, but it uses a slightly different time period and formula to remove emotional trading from the price movement of the Dow Jones Industrial Average.

The chart shows that large and well-informed investors (smart money) used last week to build positions. The sell-off on Friday was driven primarily by retail investors. That is encouraging. Combined with the Fear & Greed Index, the conclusion suggests that this is a short-term correction and that a major market crash is unlikely at this point.

Jerome Powell gets to continue in office

Current central bank chairman Jerome Powell was nominated four years ago by Donald Trump, and his term is soon coming to an end. Now, U.S. President Joe Biden has decided to nominate Powell for a second term. With this move, Biden is sending a strong signal to financial markets that stability during the current turbulent COVID period is more important to him than party politics.

The opposing candidate and favorite of left-leaning Democrats was Lael Brainard. She wanted to make greater use of the central bank to support the ecological transformation of the economy. As commendable as this goal may be, political actions are out of place within a central bank. Its credibility would suffer as a result. If greater sustainability is to be brought into financial markets through regulation, this responsibility should lie with the Treasury Department, not central banks.

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