Markets keen on the vaccine

2020 has proven to be the year from hell, yet two pieces of good news have today given markets a rocket-propelled surge. Markets were overjoyed enough with the news that the uncertainty surrounding the US election is effectively over but the news that a promising vaccine has been developed against Covid-19 sent them into ecstasy. The vaccine has been developed by Pfizer Inc. and BioNTech and is 90% effective, according to the manufacturers. It is obviously very early days to be talking about a solution to the pandemic which has produced the biggest collapse in global activity in 90 years. The vaccine may yet prove to be a damp squib, and it will not prevent the next few months being exceptionally difficult for the European and US economies. But it does represent a potential game changer. 

Market implications 

In terms of the market reaction the FTSE100 today recorded its 17^th largest daily increase on data back to 1984 (9437 observations); the rise in the CAC40 was the 10^th largest on data back to 1969 (13528 data points) whilst the IBEX recorded its 6^th biggest increase since 1987 (8829 observations). That said, all three markets remain heavily underwater for the year (chart). Interestingly, sectors which have been particularly badly ravaged over the past six months have been amongst the strongest performers. The stock price of International Airlines Group rose by 25% in the course of today, although it is still 70% below the 2020 peak recorded in January. By contrast, companies whose business model has thrived during the lockdown have underperformed. Ocado Group Plc, which provides grocery home delivery services, was down 12%. On the other side of the Atlantic, Zoom’s price was down 14% at the time of writing and even Amazon was down 2%. All this strikes me as a little premature. A lot of international business meetings will likely continue to be conducted via Zoom rather than people jetting off for a one hour face-to-face as companies continue to bear down on costs.

Whilst it may be a little early to swap your Zoom stocks for IAG, there is some method in the market madness even though it is questionable whether it should be factoring in all the good news immediately. A combination of extremely low interest rates and the prospect of an economic recovery ought to support equities in the medium-term. Accordingly investors may reduce some of their exposure to safe haven assets such as fixed income and gold and position into equities, although a prudent investor who missed today’s rally may be advised to buy on the dips since some of today’s gains will undoubtedly be given back before long. 

Economic implications 

The prospect of a vaccine has major economic implications. After all there is a lot of pent-up demand which has been postponed since the spring. But the vaccine is nowhere near ready for widespread use and even if it does get approval before year-end, as has been suggested, it is unlikely to be widely available until the second half of next year at the earliest. Accordingly the impact on the wider economy is unlikely to be felt before 2022. Over the coming months governments will thus have to continue providing support to those who have lost their jobs or whose jobs are at risk. But the prospect of a vaccine changes the calculus by resolving the duration mismatch problem which governments have faced in the course of this year.

Whilst governments want to provide as much support to the economy as possible, they are also acutely aware of the costs The UK government has in recent months been particularly hesitant to open the taps further. Only last month Chancellor Rishi Sunak suggested that “we have a sacred responsibility to future generations to leave the public finances strong and … this Conservative government will always balance the books.” But if a vaccine is in the offing governments will not face an open-ended commitment to provide fiscal support: They can act in the near-term with a high degree of confidence that an economic recovery lies ahead.

This does not change my long-held view that there will be a considerable degree of economic scarring. It is highly likely that the pandemic will prove to be a watershed for the economy. Part of the change in economic behaviour observed over the last eight months will prove to be permanent with the result that there will be a period of resource reallocation as the economy transitions to a new structure. Such an outcome could be driven by a change in tastes (e.g. a preference for online shopping rather than physical shopping, which will have major implications for the retail sector). This in turn will almost certainly result in frictional unemployment which will take some time to be eliminated. It could also mean that the sectoral distribution of capital which prevailed prior to the pandemic will have to be significantly changed, implying a faster rate of capital scrapping in those areas where it is no longer required which turn will depress the economy’s potential growth rate (at least temporarily).

The UK will find itself in a worse position than other European economies. It is becoming increasingly evident that the form of Brexit the government is intent on delivering will be a much harder variant than imagined even a year ago (I will come back to this in a future post). Accordingly it is likely that even in the absence of the restrictions imposed by Covid-19 the UK will take longer to get back to pre-recession levels of output than elsewhere.

For all today’s optimism there is still the potential for the path out of the pandemic to prove torturous and uneven. However it represents the first piece of genuinely good news in the fight against Covid-19. As The Queen put it in her April broadcast “while we may have more still to endure, better days will return: we will be with our friends again; we will be with our families again; we will meet again.” But as the old song has it, “Don’t know where, don’t know when.”