December 2020 Commentary
In the fourth quarter, the pandemic took a turn for the worse over the quarter. New infection rates rose significantly in Europe and the US, topping the previous highs. Limits to intensive care unit capacity and outbreaks in nursing homes forced governments to implement new stringent lockdown measures to slow the spread of the virus. In Europe and the UK, services are under pressure from the restrictions. In the US, the vicious autumn wave of the virus began with a time lag to Europe and the restrictions were less stringent. Therefore, negative effects on US GDP growth are likely not to be seen until Q1 of 2021. Manufacturing continues to show more resilience to the pandemic than the service sector – a trend that can be observed globally. Recovering demand for goods and lower sensitivity to social distancing, helped to keep manufacturing purchasing managers’ indices (PMIs) in expansionary territory. This is good news for equity markets, since goods and manufacturing still contribute significantly to index-level earnings.
Concerns over the rising caseload were overshadowed by the announcements from PfizerBioNTech, Moderna and AstraZeneca/Oxford in November, that their vaccines were effective in reducing symptomatic cases of Covid-19. An end to the Covid-19 crisis now appears to be in sight, but the path to recovery may still be bumpy over the coming quarters.
After approval by the authorities, how quickly these vaccines can be manufactured, distributed and administered on a mass scale will be crucial. It is worth noting the logistical challenges of the Pfizer/BioNTech and Moderna vaccines, which both require cold storage and are relatively expensive. Success will also depend on the willingness of the population to get vaccinated and the effectiveness of the vaccines against any mutations in the virus.
For equity markets, the vaccine announcement on November 9 led to one of the largest momentum changes in history. Hard-hit value sectors, such as energy, traditional retail, hotels, airlines and financials rallied, while the pandemic winners, such as online retail, health care and home improvement, lagged.
In the HY asset space, US high yield performed better than its European counterparts, closing off a strong month at 1.14%. The asset class was benefitted from the stimulus package and fed commitment to maintain rates low for the foreseeable future. Movement particularly in the energy sector, whereby a sharp recovery continued to gather pace, with prices of oil being pushed to recent highs.
The first quarter of 2021 is likely to remain challenging for the global economy. Disappointing economic data is likely to coincide with continued pandemic-related restrictions. So far, the market has broadly been willing to look through the near-term weakness thanks to the vaccine news and policy support measures but any disappointment on the vaccine front could lead to increased market volatility.
We start this new economic cycle with valuations that are higher than is normal coming out of a recession. The fall in real rates has supported valuations but, with interest rates closer to their nominal floor, such a repeated boost looks unlikely in the years ahead. More than ever, the emphasis will have to be on identifying the regions, sectors and companies that have the strongest underappreciated earnings prospects.
