Financial markets have posted notable gains month to date. And market optimism concerning the US elections has been amplified this week by hopes for a COVID vaccine. A key question for investors now is whether news of a vaccine will be enough to push risk assets higher through year-end, even as accelerating COVID infection rates threaten an already fragile economic recovery.
Without a doubt, the news of a means to quell the spread of this year’s deadly virus is a positive development for our healthcare system, our economy, and the markets. However, of particular concern remains production and distribution obstacles related to getting the vaccine out to those who need it most. These enduring questions mean that the healthcare crisis is likely to intensify before it gets better.
Even so, we believe that the recent vaccine news combined with prospects of a concerted national response to the pandemic and potentially trillions of dollars in additional fiscal spending signals that light is beginning to shine at the end of the tunnel. If hope holds out, and the economy largely remains open, then the current market rotation into cyclical sectors could continue ahead of an economic recovery next year.
Figure 1: Cyclical Market Sectors Have Benefited in Recent Months
A Rally on Vaccine News
Markets moved higher this week on news of successful COVID vaccine drug trials announced by several large drug companies. These companies reported that their vaccines showed a more than 90% effective rate, which signals that, once the drugs become widely available, the spread of the coronavirus could be curtailed as soon as the second half of next year. With global cases topping 55 million this week, top US healthcare advisors estimate that between 75% to 80% of Americans might need to receive these vaccines to stop the spread of the deadly virus.
While markets indeed have rallied on the vaccine’s positive news, the reality is that three key challenges stand between the end to the pandemic and a full-throated economic recovery. First, consider the production issues. One of the large drug companies recently announced that it might have as much as 50 million vaccine doses ready by the end of this year. Now keep in mind that each patient requires two doses of the vaccine to ensure immunization.
And assuming that the other drug companies that have also signaled successful trials can produce a similar quantity, we could see vaccine production reach 100 million doses to treat 50 million individuals every two months. While these production figures are considered optimistic, if we assume that only 80% of Americans need to be vaccinated, then there might be enough of the drug produced to help stem the virus’s spread by the summer of 2021.
Now, production is a crucial first step to ending the pandemic, yet the next issue we’ll likely contend with is the logistics of getting the vaccines to the right people. To this point, the drugs need to be stored at between negative 1- and negative 100-degrees Fahrenheit to ensure that they’ll remain effective. While one company has developed a unique workaround to transport the drug, its solution will likely create a bottleneck in the vaccine’s widescale distribution. This limited distribution means that receiving a vaccine probably won’t be as simple as walking into your local pharmacy to get a flu shot.
Finally, there’s the challenge of handling and administering the vaccine and the potential that mishandlings could affect the stated 90% effective rate. Traditionally, drug testing occurs in highly controlled, structured environments.
However, distribution will take place in real-world settings, where anxiety surrounding the virus remains high, healthcare systems strained, and doctors and nurses burnt out and overwhelmed. Mistakes are likely to occur during vaccine administration, potentially questioning the 90% efficacy rate of the drug treatments. What’s more, while an inoculation rate of 75% to 80% could help stem the COVID spread, polls suggest that a large part of the US population is still unwilling to receive the drug. This fact alone could delay the benefits of administering the vaccine.
Even with these factors in mind, some market participants remain optimistic that the potential issues related to manufacturing, distribution and administration of the vaccine will be overcome. When this happens, social distancing measures likely will ease and struggling businesses could have a fighting chance to stage a comeback. It’s this optimism that arguably appears to be priced into the markets. That is, the potential for a sustained economic recovery, assuming that concerns about COVID begin to fade into the second half of next year.
Figure 2: US Coronavirus Infection Rates Hit Record Highs in November
Market Sentiment Cautious on a Likely Rebound
Make no mistake, markets likely will contend with COVID related issues for the entirety of 2021 and potentially beyond. Of particular concern at the moment is the rapid rise in infection rates taking hold in the US and around the world.
Infections Still a Near-term Economic Concern
This week, data from the Johns Hopkins University showed that daily average infection rates topped 160,000, besting peak infection rates reported during the summer months. This rapid rise in the coronavirus’s spread has recently led to renewed stay at home advisories, school closures, and limits on dining and social gatherings across the US. While a full lockdown of the US economy is not yet in the cards, these measures enacted at the local level could dampen the modest economic recovery that has unfolded over the past few months.
As it relates to infections, the prospects of a harsh winter arguably has been baked into many economists’ GDP forecasts for the year. Expectations are set for the US economy to post a gain of roughly 4% in the fourth quarter as consumer spending and construction activity underpin growth.
This positive sentiment is playing out in the markets today. This optimism is arguably evidenced in a rotation away from the market’s liquidity-oriented sectors toward a preference for pro-cyclical sectors that historically tend to do well in the early phases of an economic rebound.
Nevertheless, a key risk for the markets now is how quickly the resurgent infection rate can be quelled and what, if any, additional economic impact might come from various stay at home advisories and limited business operating hours.
Looking ahead, an incoming Biden administration focused on broad measures to address the healthcare crisis likely will give business leaders greater confidence in a durable solution to the virus’s spread. What’s more, the issue of another economic relief package is not a matter of “if,” but “when,” and this potentially could help prevent the economy from slipping further into a recession.
Figure 3: US Consumers Contributing to Stabilizing Economic Growth
Pricing in an Economic Recovery
From this vantage point, clarity around a vaccine, a concerted response to the healthcare crisis, and more fiscal spending may provide the markets with hope that the economy likely will recover even as near-term concerns (like rising infection rates) continue to surface.
Certainly, incoming economic data suggest that the US economy is on the mend. Business sentiment has stabilized recently, and hiring activity has somewhat improved, as evidenced by a declining unemployment rate even as weekly jobless claims remain stubbornly elevated. Consumer confidence is also steadying and evident in solid retail sales and a surge in demand for home purchases.
Cyclical sectors of the markets (those that move in tandem with the economy have benefited from an improving economic narrative and greater post-election policy clarity. These sectors include US small-cap and value-oriented stocks and a weaker US dollar that has led to gains in emerging markets. As the US economy recovers, this rotation could likely overshadow the liquidity theme that supported gains in the work-from-home and the Fed’s money printing theme that has benefited the tech sector.
To be sure, as we pointed out in last month’s report, a Biden win and the prospect for higher levels of government spending has set the stage for a pivot towards cyclically oriented sectors of the markets. This view has played out in small-cap and value stocks outperforming tech in the weeks following the elections (see figure 1). Looking ahead, we anticipate this trend to continue as lingering election uncertainties fade, inauguration day passes, and business and consumer confidence steadily improve.
Are Vaccine Hopes a Shot in the Arm for the Markets?
While there is a genuine reason for markets to be optimistic about a COVID vaccine, the very real risk today is that infection rates in the US and around the globe will continue to rise. Local leaders are walking a fine line between enacting more stringent safety protocols and shuttering businesses altogether. To this point, the Fed indicated the real potential for a double-dip US recession if infection rates aren’t mitigated soon. And if this happens, the market’s appetite for cyclical investments might come to a pause.
Nevertheless, this week’s vaccine news combined with prospects of a concerted national response to the pandemic and potentially trillions of dollars in additional fiscal spending in the months ahead signals that light is beginning to shine at the end of the tunnel. If hope holds out, and the US economy largely remains open, then the current market sentiment driving a rotation into cyclical sectors could continue ahead of an economic recovery next year.