Investing

How much does the market care about a vaccine?

We don’t think the recovery needs a vaccine to continue. Here’s why.


 

Our Top Market Takeaways for October 2, 2020.
 

Markets in a minute
Ready, set, 4th quarter

October is here. And good riddance to September—it marked the first month of negative returns after five months of consecutive gains (the S&P 500 lost -3.9% in September, but still gained over +30% since the start of the second quarter). Despite the hiccup at the end of it, the third quarter was one defined by recovery from the depths of the Global Virus Crisis: both U.S. large cap and global equity markets made new record highs, the U.S. labor market added back another nearly four million jobs, and U.S. retail sales have remained steadily above pre-crisis levels.

This week, investor focus seemed to hone in on the political arena:

  • President Trump and First Lady Melania Trump tested positive for COVID-19. We want to address a few things:
    • It’s unclear how long their quarantine will last, but it’s possible President Trump misses planned rallies in Florida, Wisconsin and Arizona, as well as the second presidential debate scheduled for October 15.
    • Since the news, prediction markets gauging the outcome of the election have moved in favor of former Vice President Biden. Legally, the election could be delayed with the approval of both chambers of Congress. That seems extremely unlikely. We would also note that word came this afternoon that Biden has tested negative for COVID-19, after he shared a debate stage with Trump earlier this week.
    • With heightened uncertainty, the tone in markets is risk-off: The S&P 500 is trading in the red, and gold is rallying amid the heightened volatility. Unless the President’s health deteriorates dramatically (he is said to be well at this time, and can carry out his duties from isolation), we don’t expect this to yield a shift in responsibility to the Vice President, a new presidential candidate for the Republican Party, or a change to our views. A continuation of heightened volatility is likely, though.
  • Anyone seeking clarity on the presidential candidates’ policy priorities from President Trump and former Vice President Biden’s first debate likely went to bed disappointed on Tuesday night. Areas of the market exposed to Democratic policy proposals have outperformed (through Thursday’s close, a basket of clean energy names is up over +13% on the week versus the S&P 500 +2.5%, for example), but all in all, the lack of substance in the debate left our market views unchanged.
  • Buzz from the beltway reignited hope that a phase four stimulus package may be delivered before the election. News that household incomes declined by -2.7% in August due to lesser unemployment benefits highlighted the urgency for policymakers to come to an agreement. House Speaker Pelosi and Treasury Secretary Mnuchin were in negotiations throughout the week, but they didn’t seem to yield a viable bipartisan agreement—House Democrats went ahead with approving Democrats’ version of the bill on Thursday night, which is unlikely to be approved by Senate Republicans. We’re not getting our hopes up for a deal before November, although our above-consensus growth outlook does incorporate an expectation of one within the next six months. Still, we think the aggregate macro backdrop remains supportive for risk assets.

Politics are front and center, the air is crisper, and football season is in full swing. By those indicators alone, it certainly feels like October…but the ever-present pandemic reminds us that life still isn’t “normal.” Take it as a given that it won’t be until we manage to eradicate COVID-19, hopefully sooner rather than later through a medical solution. Below, we explore how markets are reflecting the probability and timing of a vaccine, and offer our thoughts on how dependent the nascent recovery is on achieving one.
 

Spotlight
Let’s talk about a vaccine: What’s priced in?

There are two sides to the vaccine coin—what it means for health and human safety and what it means for the macro and market environment. That being said, we’d note that Michael Cembalest, our Chairman of Market and Investment Strategy, has done a ton of work on the former—namely, the day-to-day developments of vaccines, anti-virals and other drug therapies. We highly encourage you to engage with his COVID-19 research. Today’s note will look at the other side and consider the market dynamics surrounding the vaccine process—what’s priced in? And what will happen once we finally get one?

First: When might we expect a vaccine?

Vaccine optimism has risen in recent months. Superforecasters from the Good Judgment Project estimate a 57% probability that the FDA will have enough vaccine doses to inoculate and distribute to 25 million people (just under 10% of the U.S. population) by the end of Q1 2021. It puts a probability of 34% for a vaccine between April and September 2021. Though, we’d note some frontline workers could receive one sooner.

That being said, we don’t have an edge on the vaccine timeline, but we are assuming what others are—that a vaccine is deployable to the masses by mid-year 2021, and by extension, infection curves are persistently flat.

Does the market expect a vaccine? How much vaccine optimism is already “priced in”?

It depends on how you look at it. Equities seem to be pricing in at least more vaccine optimism than fixed income markets—bond yields are at or near record lows across the curve as the Fed keeps rates low as a result of the virus fallout. But even while a collection of vaccine stocks* has added some $52 billion in market cap this year (roughly the size of Chubb or Dollar General), the increase doesn’t seem all that impactful, given the companies’ diversity of products.

Further, there are both winners and losers, and companies have reacted as “new” news has been brought to the fore, both good and bad—Moderna is up +260% year-to-date, BioNTech is up +115%, AstraZeneca (+15%) and Gilead (+0.4%) are up marginally, and Merck (-8%) is down on the year. And given company shares have swung rapidly around vaccine-related news headlines, it seems unlikely that a concrete, deployable solution is fully priced in.

Similarly, while biotech stocks as a whole are reflecting some vaccine optimism (proxied below by future sales growth expectations), much of their recent stock price gains can also be attributable to a lower cost of capital, thanks again to the Fed’s lower for longer interest rates. Even so, other potential sectors that would benefit from a clearer outlook for growth following a vaccine—like airlines, real estate, hotels and leisure, and energy—are all still expecting weakness ahead.

The punch line: The possibility that we get a deployable vaccine by mid-2021 (and that it works, and people take it) doesn’t appear to be broadly appreciated by markets.

So what happens when we do get a vaccine?

With a deployable vaccine solution, infection curves have a greater chance of falling consistently, economic lockdowns and social distancing policies grow less necessary, and by extension, economic activity and growth have a clearer road ahead. With that also comes the possibility of stronger corporate earnings and a steeper yield curve as investors grow more confident in the future.

Given fixed income markets aren’t pricing in much vaccine optimism, investors positioned for future steepening in the yield curve could see compelling risk-adjusted returns. Both cyclical stocks (companies most exposed to the business cycle) and some value stocks (companies that are trading lower than their fundamentals might suggest) stand to benefit as COVID-19 challenges dissipate and the picture for growth clears. In this vein, we think such companies could experience sharper rebounds in earnings expectations and improved valuations as investor optimism for these areas bounces back. We’ve grown incrementally more constructive on industrials, for example.

But what if it takes a lot longer than expected? Does the market need a vaccine to keep rallying?

Let’s put it this way: Life can’t fully return to normal until a vaccine exists and is distributed to the masses. Until then, flare-ups and new waves are likely to crop up, and so too are associated policy measures such as localized social distancing rules and lockdown measures. With this comes limitations to economic activity and confidence in future growth. It seems to be consensus that for the economy to fully move on from the challenges that COVID-19 brings, a vaccine solution is vital. Consensus feels like there is a speed limit on the recovery—it can only go so far and so fast without a vaccine.

However, we’d note a few important caveats that demonstrate why we think the speed limit for the economy is a bit higher than consensus. It is true that “high contact” sectors (such as hotels, transportation services, restaurants and office construction) will be hard-pressed to fully recover until we get a vaccine. However, those sectors are a small piece of the overall economic pie. And consumers have demonstrated enormous flexibility, largely due to their move to the digital economy. This has allowed for a high degree of “substitution,” or rotation and adaptation—consumers are spending more on vehicles, new homes and online retail (which, by the way, account for a larger part of the economy).

Further, there are also other clear “positives” contributing to the investment landscape, namely the likelihood of continued fiscal stimulus and lower for longer interest rates, not to mention reduced uncertainty around U.S. politics and Brexit come 2021.

That being said, we think current conditions (sans vaccine) are still supportive for further upside in risk assets in the near-to-medium term.

Summing up:

Our base case is for a deployable vaccine solution by mid-2021, and this doesn’t seem to be fully appreciated by markets at large. That being said, companies exposed to economic growth, or that have been beaten up despite stronger fundamentals, look poised to benefit the most as a vaccine is found and deployed.

Further, it’s important to note that our conviction in healthcare innovation as a megatrend driving growth in the years to come is not swayed by the timeline around a vaccine. We like healthcare for its innovation potential—from gene therapy to precision medicine—not necessarily because it could provide us with a medical solution to COVID-19 (though the sector could certainly see a boon once one comes to fruition).

*A collection of vaccine stocks refers to Pfizer, AstraZeneca, Regeneron, BioNTech, Gilead, Novavax, Inovio, Moderna.
 



All market and economic data as of October 2020 and sourced from Bloomberg and FactSet unless otherwise stated.

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All market and economic data as of October 2020 and sourced from Bloomberg, FactSet and Gavekal unless otherwise stated.

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