At this time of year, there is no shortage of prognosticators offering views on what the year ahead might look like. Most of the lengthy investment bank outlook pieces include a section on risks, and it’s fair to say that 2020 unfolded in a manner beyond the imaginations of all but Hollywood and Netflix scriptwriters.
The result is that the bar for the year ahead outlook is now remarkably low, especially as so many from last year were called ‘2020 Vision’.
This crisis has been first and foremost a health crisis. People will spend years analysing the various government responses, but the bottom line is that economies cannot operate at anything close to potential while a dangerous virus is circulating through the population. On this basis, the starting point for any analysis must begin with the virus, and the good news is that effective vaccines are on the way.
The US Food and Drug Administration is expected to meet 10 Dec. to potentially approve vaccines developed by Pfizer-BioNTech and Moderna, which trials have shown to be around 95% effective. The signs are promising and assuming they get the go-ahead, the infrastructure is in place to start vaccinating high-risk individuals almost immediately.
The UK’s Medicines and Healthcare products Regulatory Agency (MHRA) has already approved the Pfizer-BioNTech vaccine with health workers first in line to receive it.
Hopes have been significantly boosted by the Oxford-AstraZeneca vaccine results announced 23 Nov., offering not just a high level of protection but also cheaper to produce, easily stored and available for mass production, through 2021. There is some debate around the number of vaccinations required to achieve herd immunity, but it is likely that the US and much of Europe could be close to this level by the end of summer.
The impact of the pandemic has been one of dispersion, be it at the company, sector or income quintile level. On the day that Pfizer-BioNTech made their vaccine announcement, we saw a sharp rotation out of the COVID beneficiaries, such as technology, and into the cyclicals such as travel, leisure, banks and energy. It is reasonable to expect further convergence as we progress through next year, but the theme of dispersion is likely to prove persistent.
One of the pre-COVID characteristics was a focus on experiences over things, particularly among millennials. However, the pandemic caused an abrupt reversal with housing and durable goods doing well, while social activities struggled. Next summer is likely to see a surge in demand for leisure activities such as entertainment, holidays, and overseas travel to visit friends or family. Corporate travel and hospitality on the other hand, is likely to take a long time to recover as virtual meetings and working from home have become more normalised.
Retail is also going to see some convergence, as off-price retail, luxury goods and cosmetics recover. These dynamics mean that differentiation will continue to be important in other sectors such as commercial property.
To help distinguish between cyclical and structural changes, it makes sense to consider what was already happening prior to the pandemic; sectors which were thriving are likely to see stronger, more sustainable recoveries than those that were struggling.
Further government support is required to help economies through the pandemic, but the level and timing of this in the US is an area of uncertainty. Prior to the US election, there was a wide range of potential outcomes, but with Joe Biden in the White House and a Republican-controlled Senate, the expectation is now narrower at between $550 billion and $1.2 trillion. However, if Democrats win both of the Senate seats in the Georgia runoff elections in January, this would likely increase substantially. Prediction markets suggest that this is a 25% probability.
There has been increasing discussion around whether the COVID crisis will lead to a regime shift where we move from a disinflationary to more inflationary backdrop. The Federal Reserve’s new framework, which emphasises employment and average inflation, is part of this. However, due to demographics and technology, a real regime shift will require a fundamental rethink on the use of fiscal policy, and this now looks unlikely.
The combination of a recovering global economy, with monetary policy remaining very accommodative, is likely to see bond yields and inflation moving modestly higher, a steeper curve and equities outperforming bonds. However, without further fiscal support, the scope for higher yields and equity gains is more limited. Equities already price-in an optimistic outlook and we have seen muted reactions to positive Q3 earnings surprises. With little value in high grade credit, it makes sense to be defensively positioned here and await more attractive opportunities.
The post-Global Financial Crisis recovery was slow and there is a risk that we will see a similar dynamic this time. A Fed policy mistake is unlikely, but a fiscal policy mistake is a risk, as is a messy Brexit outcome or issues with vaccine approval and distribution. As TS Lombard described, the pandemic is looking “less like a regular recession and more like ‘a natural disaster’ (large shock, swift recovery).”
A world where we are talking about how to help facilitate a faster recovery is far more preferable to one where we are discussing COVID-19, Donald Trump’s latest tweet or the latest in Brexit negotiations.
This backdrop means that any surprises next year are much more likely to be on the upside rather than the downside.
Nicholas Rilley, CFA, is portfolio manager at Butterfield.
Disclaimer: The views expressed are the opinions of the writer and whilst believed reliable may differ from the views of Butterfield Bank (Cayman) Limited. The Bank accepts no liability for errors or actions taken on the basis of this information.