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COVID-19 looms on the markets again

Spiking Delta cases, supply shortages and peaking growth. Should there be cause for concern?

Our Top Market Takeaways for August 6, 2021.

Markets thoughts

Summertime sadness

Even though developed market equities are trading near all-time highs, markets are acting wary. Global bond yields are falling, which traditionally happens when investors expect a weaker growth environment. Global negative yielding debt has ballooned by almost $4.5 trillion dollars since the middle of May because of this demand for relatively safe sovereign debt.

Equity investors have also changed their preferences. Stocks most closely linked to increased mobility and decreased COVID risk have sold off materially. Global airlines are down -20% from 52-week highs, and high quality companies have been outperforming their lower quality (more cyclically exposed) counterparts.

It seems like three issues have investors on edge: the deteriorating COVID situation globally, downside risks from supply chain issues, and fears of peaking growth. In today’s note, we wanted to explore the risks from each.  

1. The most important divergence to watch right now is between reported COVID cases and COVID deaths. Clearly, the Delta variant is threatening to the unvaccinated population. Many states in the U.S. are dealing with devastating surges, and China and Israel are enforcing new restrictions despite having mature vaccination programs. 

However, the example of the United Kingdom provides compelling evidence that the vaccines are powerful tools that will allow the global economy to normalize barring a new vaccine resistant variant. At this point, it seems like the UK is through the worst of the Delta case surge without a large surge in either hospitalizations or deaths. The primary reason: over 95% of its age 50+ population is already vaccinated. 

Even though vaccination rates are relatively low in certain areas of the United States, 90% of people aged 65+ have received at least one dose of a vaccine. Delta will likely delay full economic normalization (due to supply shortages emanating from Asia) and lead to responses such as vaccine mandates and a delayed return to the office for some companies, but we have powerful tools to combat the most destructive COVID outcomes. Booster shots will likely play a very important role in economic normalization in the developed countries in 2022.

2. In the global economy, there is a pronounced divergence between supply and demand. Take German factory data for example. Orders are at their strongest levels in years, but production is still weak. What gives? It seems like supply chain disruptions and shortages in key inputs like semiconductors are hampering output, even though demand for goods is strong. 

There is good news and bad news to this. The bad news: Anyone who has taken Macroeconomics 101 can tell you that when demand is stronger than supply, prices rise. As long as the supply side of the economy has trouble keeping up with demand, we are likely to see more inflation pressures in impacted categories like automobiles.

The good news: Demand is really strong! Look at the U.S. now. Even though GDP growth came in at “only” a 6.5% annualized pace in Q2 2021, sales to private domestic producers (which strips out the impact of changes in inventories, trade and government consumption) grew at a 9.9% real pace, one of the strongest rates since the early 1980s.

3. Finally, the U.S. GDP report from last week also illustrates a divergence between output and the labor market. Real GDP has already recovered past pre-COVID levels, but there are still over six million fewer workers on payrolls than there were in December 2019. This highlights two important things. 


The first is that productivity has been strong. Said simply, the economy is producing more output with fewer workers. We think there is a good chance that productivity growth picks up over the next few years because of efficiencies gained during the pandemic.

The second is that a full labor market recovery suggests strong GDP growth in the quarters ahead. Real GDP is the combination of labor market growth and productivity (output per worker) growth. To put some rough numbers on it, just getting back to pre-pandemic levels of employment in 12 months (adding ~500,000 workers per month) suggests 4% labor force growth, and tacking on 2%+ productivity growth yields a pretty impressive ~6% real GDP growth over the period.1 So far, so good. Data released this morning suggested the U.S. economy added just short of 1 million jobs in the month of July.

What could this mean for portfolios? We think keeping a balance in equities between sectors that are most tied to economic growth (like industrials and financials) and companies with stellar long-term growth prospects that trade at reasonable prices (like healthcare and technology) is prudent. Fixed income is challenging, but we think it could benefit investors to lean in to areas like preferred equities, leveraged loans and real estate to help augment income.

While investors are anxiously assessing the downside risks associated with these divergences, we still believe that risk assets provide compelling upside, especially considering the backdrop of deeply negative inflation-adjusted, risk-free rates.        


1.Conor Sen made the same point for Bloomberg earlier this week in a much more eloquent way.  

All market and economic data as of August 2021 and sourced from Bloomberg and FactSet unless otherwise stated.

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