There has been some positive news on vaccines and the US election is now over, but does that mean tweaking Q4 2020 forecasts and a more positive outlook for 2021?
Monica Defend, global head of research at Amundi, believes both developments provide a positive backdrop for investor sentiment that will help fuel risky assets to rally, bond yields to trend higher and the dollar to continue its bear market.
She expects a divided government will mean that the incoming Biden administration will be hamstrung to pass a large fiscal stimulus package, a big infrastructure bill, and higher taxes.
This could help contain the budget deficit.
Furthermore, she thinks concerns about the growth outlook for next year without further fiscal stimulus are mitigated by the very positive news from Pfizer and the high efficacy of its vaccine.
“In short,” Defend argues, “markets are now pricing in a rosy scenario: broad availability of a vaccine, abundant liquidity, and policies that will remain accommodative forever. However, the sequence will not be so linear. The transition from relapses induced by the virus cycle to reacceleration in the second part of the year will bring volatility.”
Ultimately, she believes the duration of the pandemic will determine the form of recovery, and insists trying to label it as V, U or K shape can be misleading.
“This will leave the door wide open to an erratic growth profile in the short term and ultimately tend to confirm our central scenario of a slow, uneven and multi-speed recovery depending on the country and sector,” she says.
Gridlocked US Congress
Daniel Morris, chief market strategist, BNP Paribas Asset Management argues that a vaccine on the horizon was already being factored in to forecasts but that the US election result provides greater food for thought.
“In the short-term we’ve actually lowered our fourth quarter 2020 and first quarter 2021 GDP forecasts to reflect the deteriorating pandemic situation in the US. This leads to a bigger bounce in the second quarter of 2021, however. We haven’t changed our 2021 forecast, as we’d always assumed a vaccine would be available at some time next year.”
He adds: “The US election result is less clear cut. A gridlocked congress means less stimulus is likely, so a smaller boost to growth than we had expected.”
Jacob Vijverberg, co-manager of the Aegon Global Diversified Income Fund, is more heartened by the vaccine progress though he stresses that the economic benefits make take some time to come through. “It was expected that vaccines would prove to be partly effective, however the news that now several vaccines are more than 90% effective is a large positive surprise.
“This basically means that the most negative scenarios are now much less likely.”
He is keen to point out that due to approval timelines and supply constraints, the vaccines will not have an immediate impact on lockdowns and restrictions in the US and Europe for a large part of this winter.
From an economic perspective Vijverberg expects the winter quarters will therefore be very soft or negative in terms of growth.
Into the remainder of 2021 he anticipates a rebound, however he does not expect the EU or US economy to return to pre-pandemic levels before 2022.
Vijverberg takes a similar line to Morris with regard to a gridlocked congress in the US.“The likelihood of fiscal stimulus to offset the effects of this covid-19 wave in the US have decreased as both political parties seem unable to compromise, which is an additional downside risk.
“Equity markets did respond positively on the divided government outcome as it makes any corporate tax increase unlikely.”
Further stimulus?
Morris accepts that the fundamentals are already there for a rally through the end of the year with the better-than-expected vaccine news. But once this is priced in, however, the question will become: “What next?”
“For a more meaningful rise into 2021, the markets will need to believe that some sort of stimulus is coming. Lacking that, the momentum is unlikely to continue at the same pace.
“Reduced US-China tensions should benefit cmerging markets broadly and the tech sector, but it’s not likely to be a radically different relationship under Biden, so the upside may be limited.”
There is a similar take on things from Defend. “With Biden’s election we can expect see a more peaceful relationship with China. Let’s not be too angelic though: The Democratic Party doesn’t have a positive view of China, and Trump’s criticism will undoubtedly be echoed by the Biden administration. The tone will change, not the substance.”
Does the macro environment continue to be positive for equities and other riskier assets? And is there any concern over inflationary pressures? The answers to these questions are ‘yes’ and ‘no’ respectively from Morris.
“We are overweight risk assets. Though the pandemic remains a worry, we see little reason for safe havens to outperform from here.”
He adds: “More inflation would be welcome, but without a Democratic-controlled congress to pass a multi-trillion stimulus package we don’t see much of an increase in inflation beyond the reversal of the disinflationary impact of the lockdowns. Even if we did get a bigger increase in inflation, the Fed is very unlikely to push against it until it rose above its 2% target.”
Normality priced in
According to Vijverberg, equity markets have been quick to price in a return to normality. Equities are long duration assets and thus respond more to longer term prospects, which have materially improved despite the short-term pain. Especially sectors hardest hit during the start of the pandemic are now showing a strong rebound.
Unfortunately, as he points out, the financial situation for some is too dire, such that they might need to raise capital or go out of business. For instance, many airlines are trading far below pre-pandemic levels. And they are unlikely to return those previous levels anytime soon.
The longer-term ramifications are not yet fully known, Vijverberg concludes: “What is clear is that government balance sheets have taken a big hit. Government debt has again increased and many countries will need central bank support for a very long time to keep interest rates low.”
He adds: “We expect inflation, especially in Europe, to remain low. The large output gaps, aging and a lack of competitiveness are likely to lead to continued deflationary pressures. If inflation would increase due to other unforeseen factors, we expect that central banks would still keep rates anchored to support the recovery.”
Jeroen Blockland, head of multi-asset funds at Robeco, believes market recovery will very much depend on vaccine effectiveness and uptake. While he veers towards the base and bull case scenarios – he concedes any major set back on the covid vaccine could lead to a severe downturn in consumer and producer confidence with the multiple effects of fiscal and monetary stimulus dwindling.
Assuming vaccine development and distribution is positive, Blockland believes 2021 will be a good year for risky assets. “We expect GDP to be back at pre-covid levels at the end of 2021. We expect accommodative fiscal and monetary policy to continue and the economic cycle to move from recession to recovery. Earnings per share should return to trend – 20% growth and this will be the main driver for equities next year.”
Blokland expects some rotation out of government bonds and believes commodity prices will grind higher. He thinks this is especially the case with regard to industrial metals, if the most bullish recovery scenario sees demand rise and supply come under pressure.
