Vaccines to be a game changer for the global economy
At the depths of despair during this pandemic, the lament of politicians, epidemiologists and economists alike was “if only we had an effective vaccine” closely followed by the qualifier that “vaccines take years to produce” and “there hasn’t yet been an effective vaccine for any coronavirus”. Fast forward just nine months and vaccines are now a reality with much greater protection levels than ever dreamed imaginable. This extraordinary achievement is testament to both the ingenuity of the major pharmaceutical companies, together with support from direct funding and mass pre-ordering commitments from the outgoing Trump administration’s “Operation Warp Speed” – one of the most effective public/private partnerships in history.
The recovery in global equity markets since the COVID-lows in late March has been driven by a massive injection of monetary and fiscal stimulus, designed to offset the economic impact of the remedies employed to suppress the virus. Despite a deep global recession, and sharply lower earnings, markets have risen due to the valuation impact of record low interest rates and easy liquidity reducing the appeal of defensive assets. The market’s advance has been on narrow breadth, with the majority of gains confined to a small number of “COVID economy” winners especially in the e-commerce, digital economy space. Central banks have almost universally announced that liquidity conditions will remain easy for the foreseeable future, well beyond when stimulus would normally be withdrawn.
In regions with embedded community viral transmission (US, Europe, UK, India, Russia and South America) the contact tracing and isolation measures which have been effective in Australia/NZ/Taiwan are simply not feasible. As a consequence, the policy remedy of choice has been the blunt “scorched earth” instrument of lockdown/slowdown which has severely constrained economic growth and corporate profits. The necessary precondition for a broad-based organic earnings recovery to occur is for the impediments to growth to be removed, which in the current environment requires the successful elimination of the COVID risk. The only sustainable way for this to occur is to achieve herd-immunity via the large-scale adoption of a safe and effective vaccine. To this end, the successful completion of stage 3 trials by vaccine candidates produced by Pfizer-BioNTech and Moderna have given rise to stunning 95% protection rates effective for up to 12 months, much better than expected. The Pfizer candidate has just been approved for emergency use in the UK, Canada and now the US, and will be closely followed by Moderna and soon after the Oxford-AstraZeneca vaccine.
The rollout for these vaccines will commence immediately in the approved countries with a global rollout likely in the March quarter 2021. Make no mistake, this will be a game changer for the global economy and will likely see global growth return to pre-COVID levels by the end of 2021 leading to a broad-based recovery in corporate profits to encompass stocks that suffered most in the heavily skewed COVID economy.
The logistics of a global rollout will be challenging given the sheer scale of the manufacturing task, together with the requirement for 2 doses at a 3-week interval, ultra-low (-70c) temperature storage (for the Pfizer vaccine) and some likely consumer resistance. This means that it will take most of 2021 for sufficient immunisation levels to be reached to allow broad-based economic reopening and re-integration of the global economy. Markets always anticipate, so we are likely to see a favourable market reaction from the powerful combination of positive earnings revisions, together with on-going interest rate and liquidity support.
Over the long term, earnings growth (not interest rates) drive equity prices. Since the onset of the pandemic, we have been cautious in our approach to risk assets as a liquidity driven rally against the backdrop of falling earnings is unlikely to be sustainable. Our asset allocation philosophy is strategic (not tactical) and we adjust positions infrequently but meaningfully based on fundamental changes to the investment outlook. The more constructive outlook for share markets gives us confidence to increase the equity risk in portfolios. With the benefits of the vaccine to accrue most notably in the hardest hit offshore economies, our preference is to increase the allocation to overseas markets which will achieve the greatest earnings leverage. This increase will be funded by selling the defensive position in US Treasuries, which will also slightly dilute the USD exposure, consistent with our bearish view on the outlook for the greenback.