Friday, 13th of November 2020
“To lose patience is to lose the battle.”
– Mahatma Gandhi
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There has been considerable churn within and across equity indices this week as investors grapple with how best to respond to the impending Biden Presidency and the news that Pfizer’s covid-19 vaccine has proven to be 90% effective in stage III trials. (Impressive, seeing as flu vaccines are normally in the range of 50% effective). Ahead of the Friday open, most major indices have at least added modestly to their already huge post-election gains; and some have continued to surge higher as the transformation of the outlook causes a dramatic shift in the distribution of ‘winners’ and ‘losers’ globally. European indices (which have certainly lost out to their developed market peers so far this year) have been the strongest performers this week, with the benchmark STOXX 600 Index up +5.1% over the first four days alone. Meanwhile, the S&P 500 Index and the MSCI EM Index have added 79bps and 49bps (in USD), respectively, in that time. Still good, but not as good. Is this the beginning of a medium-term trend across equities as risk premia compress and the laggards begin to catch-up with the leaders? If so, rebalancing portfolios could be in order. But it is not obvious at this stage.
The reasons for European outperformance this week are simple to understand. One is that coronavirus restrictions have been tighter in Europe than in the US, and the continent’s economy has paid a horrific price for this draconian approach. The latest IMF 2020 growth projections for Spain, Italy, France, and the UK make for particularly grim reading. (What is more these forecasts were made before the second wave of the coronavirus began in earnest triggering new national lockdowns in many countries.) At least one highly effective vaccine being manufactured at scale in the first half of next year has greater potential benefits for the struggling European economy than for the US economy (where data shows growth continuing to recover at a decent pace). Essentially, European companies are on their knees right now and are thus starting at a much lower base (with further to fly if the pandemic can be halted before too long). Another reason for Europe’s outperformance is more structural in nature. On average, Old World indices have much less exposure to the most innovative tech companies because most such firms are American (or, increasingly, Chinese). As regular readers of this newsletter will know, Big Tech stocks have only grown more dominant during the pandemic, propelled skyward by a tsunami of retail money and understandable concerns among institutional investors about weak earnings and balance sheets in other sectors. Normally, a lack of technology leadership is something of an Achilles heel for Europe – economically and geopolitically. However, a violent rotation into value, cyclical, and otherwise stressed sectors took place this week after the vaccine announcement – and Europe’s old economy was the biggest beneficiary.
Whether a ‘reflation trade’ of this kind becomes next year’s equivalent of the ‘stay-at-home trade’ that dominated equity markets in 2020 is uncertain at this point. But what is clear is that governments will soon need to abandon (or at least taper) the countercyclical macroeconomic policies that have offset much of the immediate economic pain or risk a bond market meltdown and/or years of grinding austerity in the future; and, when the authorities do this, a wave of corporate defaults and permanent job losses is sure to follow. Mostly these will be in those sectors that the market has pushed up this week… so will that momentum really be sustained in such a scenario? Probably not. In the meantime, manufacturing and distributing this vaccine (and others as they become available) is not going to happen overnight. Indeed, it won’t happen at all this winter when most countries are dealing with the pandemic at its worst. The FDA and its equivalents in other countries are likely to approve the Pfizer vaccine right away, but vaccinating hundreds of millions of people will be a monumental logistical challenge for even the most competent governments. One issue, for example, is that the Pfizer vaccine must be stored at -70C until the day of use, so it can only be transported in highly specialised deep freezers. That will be a challenge if you are a developing country with limited access to even basic health care equipment!
So, what is the answer for portfolios if the nascent reflation trade turns out to be a damp squib while the stay-at-home stocks are in need of a correction? There’s really only one – stay diversified; and bet on the Fed and the ECB to come to the rescue either way with huge servings of liquidity, of course. Both have suggested a need to ease further in the next few months… We recommend you remain invested.
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