Election Outcome Boosted Risk-On Theme Last Week
One headline changes the narrative about the pandemic; or does it? Pfizer’s vaccine study results Monday morning are shockingly good with over 90% effectiveness in preventing infection. The news is even more incredible considering this is the pharmaceutical industry’s first attempt at combating the new virus. The odds of the vaccine study striking gold this early are tiny, which makes the results a game-changer in terms of the arc of the pandemic and validates the view of investors who were counting on an army of scientists would beat the virus.
But the timeline for a rollout means few people will receive the two-shot vaccine. Assuming speedy FDA approval this year, only 25 million people will receive it before New Year’s Day. Another 650 million people will be able to receive it in 2021: 100 million in the U.S., 120 million in Japan, 300 million in Europe. So-called herd immunity will also help to limit the spread, but clearly the virus will not be corralled any time soon.
The stock market’s initial surge is right as investors price in better times ahead, yet the magnitude of improvement is what will drive medium-term gains, and on that timeframe the virus’s spread and increases in hospitalizations could cap the market’s knee-jerk advance. New York City’s mayor, for example, is the latest politician to warn of new restrictions.
The 10-year yield is at ~95 bps early Monday, meaning it’s trying to rise above the June intraday high of 96 bps. A sustained breakout will be required to declare an end to this range-bound market which is the best barometer of the it’s-not-over-yet view.
What to Watch This Week
Covid and Vaccine News
Today’s positive news from Pfizer, and the potential for another announcement any day now from Moderna on their technology, is boosting risk sentiment across the board. This is the best news we have received yet on the pandemic, but plenty of details remain to be ironed out. As Covid cases continue to rise, we are watching to see if politicians feel freer to impose limited restrictions now that the election is behind us.
Watch the House margin and the progress of the legal challenges. Delays were expected and the market handled them fine, but big recounts are a different story entirely.
Fed Chairman Powell speaks at a European Central Bank (ECB) event on Thursday with the heads of the ECB and the Bank of England (BOE). Bond investors will look for clarity on their quantitative easing program. Consumer Confidence Surveys are released in Europe on Tuesday (ZEW), and in the U.S. on Friday (University of Michigan). Pay attention to the extent of the fall in Europe as Covid cases rise.
U.S. Election Results Helped Global Equities Beat Other Markets Last Week
Investors were drinking from a firehose of newsflow last week, but in the end equity markets liked what they saw from the U.S. election. Global equities put in their best week since the early stages of the market rebound in April (MXWD +7.6%). International developed markets led (MXEA +8.1%), clawing back some of their recent weakness, while the recent winner, Emerging Markets, advanced the least (MXEF +6.6%). Domestic equities finished up 7.4% (SPX), with strong outperformance from the tech-heavy NASDAQ 100 (NDX +9.4%) [Figure 01].
Within the U.S., every sector was up last week, but there was considerable divergence as investors assessed the next two years of likely policy from Washington. Growth led value by over 3% and small-caps lagged their larger brethren as the hopes of a stimulus-fueled rotation into those beaten down market segments were dashed by the likely divided government. We had been skeptical of this line of thinking, but it once again shows how much the market wants to believe in a rotation into this year’s laggards. There will be a time for that, but the fundamentals need to accompany the price action, and so we wait yet again. Pfizer’s vaccine has the potential to change that relationship but value still remains well below its March high in early Monday trading. Contrast that with growth which is within reach of rising above its all-time high set in September [Figure 02].
Election Uncertainty Remains but the Market is Running with a Divided Government
At this time, the Presidency has been called for Joe Biden, but there is uncertainty about the balance of power in the Senate. Two run-off races in Georgia in early January will determine who has control there. Democrats lost seats in the House, and we think that this fact is being overlooked amidst all the news. Regardless, this result clearly weakens the electoral mandate of the next government and rules out the vast majority of the progressive policy agenda. For the market, which cares about taxes and regulatory policy above all else, that is a result to be cheered.
The CBOE Volatility Index (VIX) plunged last week as investors priced out a contested electoral result. This fall in volatility will likely lead to rerisking in equities by systematic investors in the coming weeks – last week’s gains may not be all we see in 2020.
Economic Growth Continues to Surprise to the Upside, But Covid Isn’t Done
Another positive development last week was the strength in the US jobs report. Economic growth, especially in the US and Asia, continues to surprise to the upside. The U.S. consumer remains the bedrock of the economic recovery.
Tempering the optimism, and preventing the much yearned for rotation into this year’s laggards, is the Covid situation. Most of Western Europe is in lockdown and cases, hospitalizations and deaths are rising in the U.S. Regrettably, this issue has become politicized, so we are watching to see how last week’s election impacts behavior and the government’s response. Monday’s vaccine data has the market excited about a return to normal, but the pandemic is still raging and distribution of the vaccine will take time.
Interest Rates Last Week Priced out a Massive Fiscal Stimulus Package
Fixed income had a similar reaction to equities, pricing out a Blue Wave scenario and rallying on the risk-supportive divided government outcome. Bond investors had been worried that massive stimulus under a Democratic-controlled government would further balloon the deficit. With that appearing to be off the table, yields plunged and the curve flattened dramatically (10yr -5 bps, 30yr -6 bps).
The 30 year yield had its biggest daily fall since April on Wednesday. While it crept higher for the rest of the week, a divided government limits the size of the next fiscal package and leaves monetary policy firmly in control. That is good for asset prices, stocks and bonds alike, but it won’t induce above-trend economic growth and lead to a sustained inflation overshoot. Yield seeking in the fixed income market is alive and well.
Credit spreads compressed materially last week (Investment Grade (IG) -8 bps, High Yield (HY) -67 bps). HY spreads are back to their late-February levels, and while policy will likely keep them tight, we think there is better risk/reward to be had in other areas of the fixed income market.
Central Banks Maintain Easing Bias Across the Globe
Global central banks had a busy week as well. The Fed, meeting on Thursday, tried to stay out of the news as much as possible and succeeded. But central banks in the UK and Australia eased policy more than expected, a reminder that the pull toward easy monetary policy is global, not just in the U.S. The amount of global negative yielding debt hit at a record high – over 17 trillion dollars – on Friday [Figure 03]. It is hard to come up with a better illustration of the global cap on interest rates than that!
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