After the euphoric reaction to the apparent breakthrough on the coronavirus vaccine last week and the US Presidential election result, where are we heading with investments as we head into the last six weeks of 2020?
Markets Jump on Coronavirus Vaccine Breakthrough
Certainly, the path of coronavirus around the world and its economic impact continues to dominate news wires. After a difficult early autumn, markets jumped on the announcement by Pfizer and BioNTech that their vaccine has 90% efficacy for COVID-19 symptoms. Finally, there is light at the end of the tunnel. The UK FTSE-100 broke through the 6000 barrier, the Nikki hit a 29 year high and the picture was similarly positive around the globe. The upbeat mood saw a strong bounce in beaten up sectors, such as energy, financials, property, retail and leisure; and a corresponding softening in companies benefitting from lockdown measures.
Sticking with the positive message, the US is planning the biggest ever vaccination effort with hundreds of millions of doses and US Operation Warp Speed, the government initiative to accelerate the development and distribution of vaccines has the full backing of the new president-elect. Furthermore, there are hundreds of other vaccines and treatments being developed. Indeed, amongst others the Oxford-AstraZeneca and Johnson & Johnson vaccines are in their final stages of testing and the German CureVac treatment looks promising too. It seems assured that over the next year or so, finally the cavalry will arrive and help facilitate a gradual return to normal life, a critical requirement to underpin a meaningful economic recovery.
Coronavirus Reality Check
However, just as markets tend to fall too far when bad news hits, they also tend to overshoot on the upside. A reality check is called for with COVID-19 as it will time some time for the world population to receive the vaccination and countless problems remain in the short-term. Antarctic is the only coronavirus-free continent. In the US, the situation is deteriorating rapidly with 120,000 new daily cases, 10.3million total cases and nearly 250,000 deaths. The situation is so bad in North Dakota that nurses who have tested positive are still being asked to work if they are not showing symptoms. In Europe, prolonged and repeated lockdowns are hitting the economy as winter approaches in the northern hemisphere. In Italy, hospitals are severely strained; France and Germany are struggling to bring the new case count down and the UK has over 30,000 new daily cases. Even, South Korea which has been praised for its handling of the crisis, has recently introduced fines for non-compliance with mask-wearing as new cases have risen to 200 per day. The pandemic is not yet over.
There are also practical difficulties with the new Pfizer vaccine. It requires two doses and most significantly needs to be stored at -80c, requiring special freezers in hospitals and clinics, which are not commonplace, except in the context of fertility treatment and cryogenics. With regard to cost, typically four fifths of the total cost of vaccines is cold storage and transport. In terms of the manufacture of the Pfizer vaccine, only 50 million doses are expected by the end of 2020 and 1.3 billion in 2021, enough to inoculate only around 8% of the world population. The good news is that Pfizer is developing a powder version of its vaccine which does not require such cold storage; competing vaccines also have the advantage of a single dose and being stable at more normal temperatures.
US Elections – Joe Biden President-Elect
After an acrimonious election campaign, Joe Biden is the new US President-elect. Despite President Trump’s refusal to concede defeat at this stage and potential legal challenges, markets have reacted very positively. Whilst President Trump was seen generally as friendly to business with tax cuts and de-regulation, his irascibility frequently caused market volatility, particularly with regard to US-China tensions.
Mr Biden is viewed as altogether more predictable, diplomatic and less confrontational than Donald Trump in respect of foreign affairs. His appointment of Ron Klain as his chief-of-staff, who is viewed as a safe pair of hands, supports the view that the new administration will mark a return to business as usual in Washington.
President Trump’s claims of electoral fraud seem unlikely to gain any traction. Indeed, Federal and State officials have declared there is no evidence that votes were compromised and they have added that the elections were the most secure in US history.
Markets Welcome New US Political Landscape
The President-elect is expected to re-engage with the international community ending Trump’s ‘America First’ policy, including re-joining the Paris Climate Change Agreement and World Health Organisation. With regard to China, Mr Biden is likely to continue the policy of protecting US companies’ technology and intellectual property, as well as standup to China on issues ranging from North Korea to Taiwan and military bases in the South China Sea. However, the tone is likely to be different, treating China as a competitor rather than an adversary. In the short-term, US-China tensions should be reduced as Mr Biden’s prime focus will be domestic dealing with COVID-19 and re-invigorating the US economy.
Investment markets had been concerned about a ‘blue wave’ Democrat landslide for Mr Biden, since he had advocated a raft of measures which were viewed as unfriendly for investors, particularly much higher taxes for individuals and business, higher public spending and significant regulation of sectors ranging from large technology companies to banks, energy and healthcare.
Republican Senate to Check Democrats’ Agenda
However, it appears that the Republicans have retained control of the Senate, subject to two run-off elections in Georgia in January. This means that the Senate will potentially be able to restrict the President’s ability to pursue much of his programme, resulting in a watering-down of his more socialist proposals. The Republican leader in the Senate, Mitch McConnell is a formidable adversary and has been nicknamed Darth Vader and the Grim Reaper for his ability to make the Senate a legislative graveyard; a phenomenon experienced by President Obama in his second term when legislation was frequently thwarted.
Brexit Trade Negotiations
Joe Biden’s victory is also casting a shadow over the UK’s future role in the world having left the EU. The hope of a quick trade deal for the UK with the US as mooted by President Trump, now looks a forlorn hope. This is because Mr Biden is proud of his Irish family background and would not contemplate an agreement if the UK government might breach the terms of the Good Friday Agreement.
The lack of a deal with the US for the UK has strengthened the EU’s negotiating position with regard to a possible trade deal, unless the UK is minded to go it alone as a Singapore-on-Thames from 1 January with tariffs on World Trade Organisation terms.
It remains unclear if the UK will agree terms with the EU as negotiations continue. However, the UK government has confirmed it intends to continue with its Internal Markets Bill which contains powers in breach of international law, despite a heavy defeat in the House of Lords. The next few weeks should provide greater clarify with regard to the UK’s future role in the world from a political perspective and its economic orientation.
Global Economy
COVID-19 has cast a dark shadow over the global economy. It is well understood that 2020 has resulted in a sharp drop in economic activity in almost every part of the world, with double digit drops in GDP commonplace. Amongst major economies, only China is expected to finish the year with positive GDP growth. Finally, the Chinese stock exchange has overtaken the last market peak in 2015 with a total value of over $10 trillion, a reward for a growth story which is lacking in other parts of the world.
Brighter Outlook for Asia with Historic New Trade Agreement
In fact, northern Asian countries are emerging from the pandemic in better shape than Europe or America. They dealt with the crisis more decisively and suffered a lower human and financial cost as a result. Japan is likely to benefit from this in the future, with favourable valuations, a new prime minister, Mr Suga, and an export-led economy ready to sell into recovering Asian markets and a buoyant China. Indeed, Japan’s economy, the third largest in the world, bounced by 21% in Q3 2020 reflecting a strong recovery, although not yet back to pre-COVID-19 levels; a similar picture of strong economic recovery is emerging in China.
The outlook for Asia has brightened further with the signing of one of the biggest trade deals in history. The Regional Comprehensive Economic Partnership (RCEP) is a free trade agreement between 15 Asian nations, including China, Japan, South Korea, Australia and New Zealand, as well as the Association of Southeast Asian Nations (ASEAN) countries. It results in the largest trading block in the world, overtaking the EU and US by some measures and has been estimated it will add $200 billion to the global economy and 0.2% GDP to its members. It is likely further to strengthen China’s economic influence and power in the years ahead, one reason why to date India is a noticeable absentee from the RCEP. China’s involvement belies the view that China does not support free trade or multilateralism. Other than China, exporting nations, such as Japan and South Korea should be the biggest winners from the new agreement, but the benefit of cheaper goods should be felt in Europe and the US too.
The challenge is for governments and central banks to avoid an economic ‘long COVID-19’ by withdrawing support too soon and hiking taxes, resulting not just in a deep recession in 2020, but years of debility with weak growth, high unemployment and economic scarring.
This is particularly salient as government debt is around 120% GDP, which was last seen in World War II, a consequence of $11.7 trillion which has been spent by governments on the pandemic according to IMF estimates. This is a massive 12% global GDP and dwarfs the financial support given in the aftermath of the global financial crisis of 2008-9. The key is for governments to move from rescue packages to promoting sustainable growth.
However, many listed companies have proved to be surprisingly resilient. This has been evidenced by US Q3 earnings which to date have been around 20% higher than anticipated by analyst forecasts.
Reasons for Optimism
There are three primary reasons to feel positive about the market outlook. Firstly, coronavirus will be brought under control as effective vaccines emerge. This will be gradual, but 2021 should see real progress with the roll out of vaccinations around the world. As life begins to return to normal, so can economic activity.
Secondly, interest rates are anchored at historically low levels, almost zero, which is supportive for equities and economic recovery. The stand-off between the new US President-elect and a Republican Senate should help ensure the period of low interest rates lasts until at least 2023 as previously forecast by the US Federal Reserve ad more recently the Bank of England. The Republican Senate is likely to trim Mr Biden’s proposed $3 trillion stimulus package to a skinny $500 billion on the basis of its fiscal conservatism.
Thirdly, further financial stimulus is anticipated by governments and central banks, not just in the US, but Europe and the UK. Last week, Rishi Sunak, UK Chancellor, announced a further £150billion stimulus (Quantitative Easing) to bring the total level of support to £895 billion in 2021 in response to the UK’s double-dip recession in 2020. As well as monetary support by central banks, fiscal support by governments is also supportive of the global economy and should result in a pick up of growth in 2021 as vaccine programmes start to bring an end to the health crisis.
Summary
In the short-term, the initial euphoria from the breakthrough in respect of the development of an effective vaccine may wear off as the reality dawns that it is still at least six months or more before the virus is likely to be brought under control globally. This means, inflationary pressures are likely to be benign for the foreseeable future, particularly with central banks seeking to keep a tight lid on interest rates and bond markets. As such, reflation, which is necessary for cyclical, economically sensitive and smaller companies to prosper is unlikely. This is particularly the case with the level of public and private debt, as well as the powerful secular trend of digitalisation resulting in little wage pressure and ageing populations in many parts of the world. Cyclical companies may have to wait until later in 2021 when the economic recovery is assured.
Looking further ahead into the second part of 2021, a more robust economic recovery looks likely provided that governments continue to support sustainable growth so the private sector can pick up the slack in the economy and re-grow the economy to pre-COVID levels by mid-2022. Indeed, both JP Morgan and Goldman Sachs have bullish forecasts for the US stock market of 11% upside in 2021.
Potentially Attractive Investment Opportunities
Exporting nations should prosper with accommodative government economic policies, notably Germany, China, Japan and many emerging countries. Companies engaged in green energy and sustainable investments should profit from the renewed focus on climate change and Mr Biden’s interest in this area. Technology is likely to continue to dominate too as the pace of change continues to quicken, particularly with exciting developments in artificial intelligence, including GPT-3. The key for investors will be to diversify beyond the big five US technology giants of Amazon, Apple, Alphabet (Google), Microsoft and Facebook. Healthcare and consumer staples should also continue to deliver results to investors as their strong cash flows and balance sheets will remain attractive. Government spending on healthcare is likely to remain elevated and breakthroughs in medical science should support valuations over several years.
After a rollercoaster year in 2020, whilst we need to keep a sense of perspective in that the recovery will take time to come through, there are now genuine reasons to be cautiously optimistic for markets as we look ahead to the end of the year and 2021.
Please note, our Market Overview & Outlook is our view of markets and does not constitute investment advice. Past performance is not necessarily an indication of future returns; the value of investments and any income from them is not guaranteed and can fall as well as rise. Overseas investments are affected by currency movements and exchange rates. If you would like investment advice on your individual circumstances, please do not hesitate to get in touch, telephone 01392 875500, info@clients@SeabrookClark.co.uk