Well, we certainly took a giant leap forward Monday with the Pfizer announcement on the efficacy of its Phase 3 COVID-19 vaccine trial: More than 90 per cent almost seems too good to be true, and we hope it is true.
The next stage will concern safety and then comes durability. But if Pfizer Inc. is successful here, it surely is a game changer. And there are other companies lining up right behind.
I had been in the camp of Dr. Anthony Fauci, where a vaccine was more of a late 2021 story with perhaps 60-per-cent efficacy. Now that timetable may well be moved up to no later than late in the first quarter and, at 90 per cent, there is no longer the fear that a take-up is going to be low.
The bottom line is that downside economic risks, which always have been tied to health risks, have subsided sharply.
The market reaction smacked initially of a surprise-led short covering rally in value stocks. Energy, banks and travel stocks soared. Anything linked to getting life back to normal absolutely flew on Monday.
That rotation trade continued into Tuesday. The tech, communication services and consumer discretionary indexes of the S&P 500 were down 1-per-cent each at midday, as investors moved to sectors expected to benefit from a full reopening of the economy, such as energy and industrials. Value-linked stocks, which tend to outperform coming out of a recession, added 4 per cent.
The yield on the 10-year U.S. Treasury note on Monday jumped 11 basis points, to 0.92 per cent, and is testing critical support levels on Tuesday. Gold is up on Tuesday but hasn’t recovered from its 4.4-per-cent fall on Monday.
While it is obvious that good news on the pandemic will cause a selloff in the havens of gold and Treasuries, it must be remembered that before the pandemic, both asset classes were in full-fledged bull markets.
So I want to make this point and make it emphatically. Any selloff from a vaccine will just be a buying opportunity. Treasuries and gold were in secular bull markets before anyone even knew what COVID-19 was. To me, these are corrections in bull markets. They come and they go. Equities are not the only asset class constantly being bought on price dips.
All that said, there are tailwinds for the equity market here, and the value stocks are still so cheap in relative and absolute terms that this trade could persist a while longer. But at this point, the Pfizer news has to go from success in a trial to something real and tangible.
What happens if we return to normal?
A lot did get priced into markets on Monday. If the initial market reaction is correct, then we should be seeing the inoculations begin by the end of the first quarter of 2021. This is what is being priced in. That means no first-quarter U.S. GDP contraction and it means a likely second-quarter economic boom.
We shouldn’t be too dismissive of the timing. First, winter is coming and that means, absent a vaccine, the case counts, hospitalizations and fatalities are likely to get worse. Human nature is such that people will now be willing to be patient with the vaccine coming soon. As in, why screw this up? So this, along with thin U.S. stimulus spending, does complicate the economic backdrop for this quarter and perhaps into the first quarter of the new year.
If people begin to see that life is going back to normal, we are talking about a US$700-billion hole in the consumer-services area of the economy (like airlines, rail, hotels, restaurants, retail, etc.) that will get filled, and likely rather quickly. This is a 3-per-cent boost to U.S. GDP right there, not including all the other multiplier effects from a speedier pace of job creation and generally increased economic confidence.
This is not my call, but it is now not out of the realm of expectations that a return to normal, or something close to normal, can occur as early as the first quarter.
Remember that the pre-COVID-19 world was still one of slow growth, low inflation and interest rates that had no capacity to rise for very long. This is what hangs in the balance for 2021. If a vaccine comes in the first quarter and people start to get inoculated, we stand a very good chance of seeing 4.5 per cent real GDP growth. Even if the vaccine’s efficacy is only 50 per cent, the timing would be so significant in terms of being earlier than expected that real GDP growth would still come in, according to our models, at 3.8 per cent. But if this turns out to be a 2022 story, we are talking about a sub-1-per-cent performance next year, possibly flat.
So here’s the deal. If the transition is a smooth one and the Pfizer news has validity, there is no reason why the economy doesn’t then start to turn normal again. Or as close as possible. People will still want to work from home. And people will still want to cook and use their Peloton bike. If we have an effective vaccine, most gyms will reopen as will restaurants, hotels, airports and shopping centres. The only areas I would be cautious on in this scenario would be office real estate investment trusts – but mall REITs will do just fine.
But if the markets have jumped the gun this week, the value trade will quickly morph into a value trap. Which is why some continued diversification in the “stay-at-home” theme – including U.S. Treasuries and gold – is prudent, even if you buy into this latest hope-based market move.
David Rosenberg is founder of Rosenberg Research, and author of the daily economic report, Breakfast with Dave.
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