Over the last week, two pharmaceutical firms have made announcements on COVID-19 vaccines with efficacy levels above 90%. This is very positive news. The high efficacy rate should result in quicker approvals and be a positive read-through to other vaccines using the same molecular platform.
There are still questions around safety to be clarified, especially for the elderly and those with underlying conditions. An emergency use authorisation (EUA) safety report has yet to be published – it is expected in the next few weeks – which should answer some of these questions.
It will take time for the vaccines to be readily available, and as such lockdowns will not be lifted soon. There are also logistical challenges to be managed – creating storage facilities, organising medical staff to administer the vaccine, convincing populations of the value of a vaccine – which will prolong uncertainty about the timing of an exit from the health crisis.
Nonetheless, the vaccine news increases confidence, upgrades the growth outlook and provides a boost to cyclical stocks and those names and sectors that have suffered under COVID-19.
Meanwhile, new COVID-19 daily infections have continued their sharply upward trend globally. They are now close to reaching 600 000 per day (7-day average). Moreover, the number of fatalities also continues to climb, with almost 9 000 deaths recorded daily. This situation will increase the pressure on the authorities for further lockdown measures in spite of a potential vaccine breakthrough.
If anything, the prospect of a vaccine makes it more likely restrictions will stay in place or are increased as governments can at least foresee an end to them in the not too distant future. An ongoing rise in cases, hospitalisations and deaths are the key risks to the financial market’s optimistic response to the US election and positive vaccine news.
Due to the second COVID wave, we expect global central bank policy to remain very accommodative with both the US Federal Reserve and the European Central Bank likely to expand their asset purchase programmes at the December policy meetings. The vaccine announcement will not meaningfully change their views that more support is needed.
This, in turn, will likely keep global bond yields anchored for now, and financial conditions accommodative, supporting risky assets.
We remain constructive on global equities and expect to see more rotation into value/cyclical stocks, and more diversification geographically, underpinned by the vaccine-led reflation trade.
Accommodative central bank policies and an improving earnings-per-share (EPS) outlook mean the equity risk premium is attractive for now. Equities are likely to remain a key investment going into 2021.
While the unlimited accommodation by central banks might keep interest rates from rising too far, long-end rates are likely to adjust further as the improving vaccine backdrop filters into growth. Moreover, market expectations of higher inflation will increase, driving inflation break-evens up over the medium term. Central banks are certainly in no hurry to forestall an increase in inflation.
In credit markets, we see a rebound in COVID-19 sensitive sectors. Provided the efficacy and availability of these vaccines are confirmed, it is likely credit spreads will tighten further to pre-pandemic levels. Defaults are expected to peak in the first quarter 2021, but the market is likely to look through this.
Default rates picked up after the virus outbreak, but they have not risen to the levels seen in the wake of the Great Financial Crisis (GFC), as accommodative central banks and governments have provided a supportive backdrop for corporates. Dispersion will, however, remain high, especially in high-yield bonds.
The near-term economic outlook in the developed world remains challenging as a second wave of virus infections and deaths has led to renewed lockdowns in Europe. In the US, the virus is entering a third wave, making the prospect of further lockdowns likely, especially in Democratic states.
The longer-term prospects, however, are much more encouraging. Even though the final outcome of the US Senate race is still uncertain, we see a Biden presidency and a Republican Senate as the most likely scenario.
To many, this is not a bad outcome for markets as it will likely involve little change to corporate taxes and regulation. However, the possibility of a Biden presidency and a Democrat Senate (a ‘blue wave’) cannot completely be ruled out. In our view, this would open the door to a very large fiscal expansion (c.10% of GDP) which would be highly supportive of the US economy and risky assets.
The macroeconomic environment is certainly more constructive now than it was a few months ago and the balance of probabilities has shifted towards a healthy reflationary environment. Positive surprises are still possible, for example, if other vaccines prove effective and increase the chances of mass rollouts. A Democratic Senate is also an upside risk.
The main downside risks stem from renewed lockdowns in the US leading to weaker economic activity; a messy handover of power from President Trump to President-elect Biden; and any setbacks on the vaccine front.
Any views expressed here are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may take different investment decisions for different clients. This document does not constitute investment advice.
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