Successful vaccine rollout? | February 2021

 

 

In this episode we’ll be looking at whether vaccines can outrun new variants and what this is likely to mean for economies and stock markets.

Let’s start by looking at the virus situation. The vaccine rollout appears to be gathering pace, but new variants threaten to undermine some of the good work. It seems equity investors still believe the vaccine will triumph – where do you think the balance lies?

Despite higher levels of new COVID-19 cases prompting stricter lockdowns in many parts of the world, the MSCI All Country World equity index (ACWI) is currently up around 3% so far in January1. This optimism is largely down to the COVID-19 vaccine rollout, plus some ongoing stimulus and expectations of an earnings recovery.
There are reasons to be encouraged: globally, around 1% of the population have been vaccinated, at a run rate of nearly 4 million per day2. The new Biden administration has promised to deliver 100 million shots to Americans in his first 100 days. Given the current pace is 1.5 million per day and rising, this seems to be an achievable ambition3. While that would only immunise around 30% of the population, it should nonetheless, protect front-line workers and the most vulnerable to the virus. In turn, this should reduce hospital admissions and encourage the US authorities to lift lockdown restrictions.

Can you see lockdown in the UK being lifted anytime soon? And how is the economy faring under lockdown 3.0?

In the UK, the government has made lifting lockdowns dependent on vaccinating 15 million of the top four priority groups4. Given that 6.3 million people have already received their first shot, the inoculation program is on track to meet this target5. Potentially this would allow schools to open after half-term on 22 February and non-essential shops by mid-March.

Moreover, the third lockdown is likely to have less impact on growth than previously. Unlike last spring, construction and manufacturing firms have remained open, while retailers can provide click and collect service and have had more time to adjust to provide online deliveries.

Do you think markets are sufficiently pricing in the risks associated with the vaccine rollouts?

Considering the gains seen in equities since last March, there is plenty of market risk dependent on the efficacy and speed of the vaccine rollout. Mutated strains of the virus may emerge which are more resistant to current vaccines, and the population may not be inoculated fast enough to drive consumer confidence and spending up.

As an insurance against this uncertainty, governments around the world have shown a willingness to take pre-emptive action to stimulate demand and protect against downside risk to the economy. For instance, following the $900 billion pandemic relief package already legislated by US Congress in December, President Biden announced the $1.9 trillion “American Rescue Plan” in January. While not all elements of this latest fiscal package will end up in law, $1,400 stimulus cheques to qualified individuals (on top of $600 payments passed in December) and more generous unemployment benefits should pass the now Democrat-controlled Congress6. This front-loaded boost to take-home pay increases the likelihood that consumer spending can recover quickly to boost growth. Consensus forecasts are for US real GDP to grow by 4.1% in 2021, which if realised would be the fastest growth rate for 21 years7.

It is largely because of the vaccine rollout, stimulus measures and economic recovery that analysts continue to remain upbeat about company earnings. The consensus range for MSCI ACWI Earning Per Share annual growth has held remarkably steady at around 28% and 16% for 2021 and 2022 respectively, since the summer8. This fundamental support suggests that equities can continue to rally even during the pandemic and lockdowns.

Do you think inflation is likely to rise? And if so, will it be a boost for “value” markets such as the UK & emerging markets?

The short answer is yes. The direction of inflation, and particularly in the US, is likely to be an important determinant for relative equity market performance. US implied inflation (derived from the Treasury market) has swung round from 0.5% per annum over the next 10 years last March to 2.1% currently, the highest rate since late 20189. This is consistent with the Fed’s policy change last summer to encourage higher inflation.

The macro backdrop appears a little more inflationary. Given high involuntary household savings rates from fiscal stimulus, pent-up cyclical consumer demand could absorb slack in the economy, as a result of the pandemic easing relatively quickly. Structurally, the downward pressure on wages (and inflation) from the last couple of decades may be reversing too. China’s working age population started to fall in 2011, reducing the size of the global labour pool, and this could lift future wage rates10. Furthermore, manufacturers may bring more costly production closer to home to avoid COVID-related supply chain issues. If realised, this de-globalization could raise future inflation rates.

We see investment implications from higher US inflation expectations. Looking at data going back to 2009, we find that “value” orientated equity regions like the UK and emerging markets typically outperform their global peers in a rising US inflationary environment. These markets benefit from their relatively high exposure to value sectors, such as energy, materials and industrials, and low valuations.

Is there anything else to recommend these markets?

Both the UK and emerging markets are also likely to profit from an easing in idiosyncratic risks. UK equity valuations should improve following the Free Trade Agreement in goods agreed with the EU at the end of last year, while emerging markets should gain from an expected multilateral approach by the US over trade policy under a Biden administration, compared to Donald Trump’s policy to impose ad-hoc trade tariffs on China. The UK and emerging markets fit into our “Loving Unloved Stocks” theme for 2021.

 

Sources
1, 2, 3, 6, 8, 9 Refinitiv Datastream, 20 January 2021
4 Pantheon Macroeconomics, The weekly UK Economic Monitor, 18 January 2021
5 HSBC Global Research, US Fiscal Policy report, 20 January 2021
7 Bloomberg, 20 January 2021
10 The Inflation Outlook, Raymond James, 19 January 2021

 

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This episode was recorded on  26/01/2021

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The Pulse from Smith & Williamson

Investment Show: Successful vaccine rollout?

Episode 18

Broadcast on Smith & Williamson at 09:00, 28th of January 2021

Available online from 10:00 on the same day .

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