As we start the new year, we’ll be hoping that it’ll be a happier new year than 2020, and that’s all about the vaccines versus the virus.
On Christmas Eve, the UK and EU signed the long-awaited Trade and Cooperation agreement. A few days later, the US Congress passed a fiscal stimulus plan and President Trump has signed it into law. More important than either of those events, was the decision by the UK regulator to authorise the AstraZeneca/Oxford vaccine. Given these three pieces of good news, it is perhaps not surprising that equity markets have done well: up a fairly consistent 2% in developed markets since the day before Christmas Eve, with an even bigger move up for China and India.
Brexit trade deal could prove to be disappointing…
Yes, the Trade and Cooperation Agreement between the EU and the UK is better than no deal, but the negotiating logjam has been broken by making it all subject to review. It can be cancelled by either side with just 12 months’ notice. And even those areas of services where we have a deal, such as the ability to exchange data, are subject to even shorter notice periods – just six months. So, using the names and addresses of clients in the EU could become very difficult. When this agreement is looked at in more detail, the judgement may well be that it is better than nothing, but not by much.
…but there is positive fiscal news for the US
Over in the US, the fiscal news is unambiguously positive. Just when we had all but abandoned hope of a budget deal, the outgoing Congress and Administration settled their differences and passed one. It’s bigger than just about any previous fiscal package, except those passed last summer after the US succumbed to the first wave of the pandemic. Where negative US growth seemed a possibility in the first quarter of 2021, the opposite now appears likely. Because Congress and the Administration delayed agreement on the package for so long, many of the old fiscal supports expired, and spending fell as a result. On Friday, we get the US employment report and it could well show the first increase in unemployment since it peaked last April. This will be an important test of market sentiment.
The markets should ignore the bad news, looking forward to salvation in the form of vaccines. This is important because the fourth-quarter reporting season will also get going in the next few days – when companies will report some bad numbers as the US, and most of the rest of the world, suffered from second waves of infections. Again, markets will have to look through the bad numbers. All those analysts who wrote their 2021 outlooks without taking account of the vaccine rollout are revising their earnings projections up for the full year, and these revisions should be significant.
What should we be worried about?
First, and most obvious, the market is optimistic, even complacent, and valuations are stretched, except relative to interest rates, which remain ultra low. Second, I expect inflation worries to rise in the next few months, even though I am confident that there won’t be a sustained rise in inflation.
Why these near-term worries? First, as economies recover, there is always a bounce in some of the previously depressed prices. Usually this is seen in goods prices, but with this recession it will be service sector prices. Second, food prices have been soaring, with bad harvests and supply disruption due to Covid to blame. US breakeven inflation rates are edging higher.
The reason why these increases won’t be sustained is that even as economies recover there is still plenty of slack that will keep downward pressure on wages and prices. So, I think markets will look through the near-term worries on the economy and earnings.
Vaccines could pose the biggest threat
A bigger concern would be problems with the vaccines themselves. Will logistical problems damage the ambitious roll out plans? When offered a vaccine, how many will say no? Will the virus mutate and defeat the vaccines? How long will immunity last? And vaccines almost always reduce transmission, but by how much?
So far, take up in the UK has been exceptionally high. If you’re over 80, vaccine side effects pale into insignificance versus a virus that is likely to prove fatal. We’ll see if take up remains high when it is offered to younger and lower risk groups. The UK has also decided to delay giving the second dose in order to maximise the number of people given a first dose. The crisis in the UK isn’t a shortage of ICU beds, it is a shortage of staff, with many nurses and doctors off because they have Covid, are isolating, or can’t send their children to school, hence the government’s desire to keep schools open.
In the US, the vaccine has been politicised and there is more resistance, including, according to some reports, among healthcare professionals. And with decentralised private sector healthcare systems, some states are struggling to distribute the vaccines that they have been given by Washington.
Where does all this leave us?
I’m bullish but only mildly so. There’s a lot of good news priced in. The travel and leisure sector, where I was bullish last September, is within 15% of its highs, having doubled since the lows of last spring. I don’t think there’s much upside there, but the world economy as a whole is set to recover this year, and corporate earnings will rise with it.