Stock markets have been rallying on hopes of a potential vaccine breakthrough.
Earlier this week, Moderna announced that its experimental Covid-19 vaccine was 94.5% effective. The announcement echoed Pfizer’s update a week before that its vaccine was more than 90% effective against the virus.
The positive vaccine news has cheered investors and sparked hopes of a major global economic recovery next year. For months, investors, businesses and politicians have viewed a successful vaccine as the most important catalyst in bringing about a sustained global recovery.
Many other vaccine candidates are still in development, and the promising test results from Pfizer and Moderna suggest that vaccines could be key to fighting the coronavirus.
Vaccine progress is now the major driver of stock market moves. All three major US stock indices advanced to record closing highs on Monday (Nov 16) after Moderna’s news, with the S&P 500 gaining 1.16% by the end of Monday’s session.
Is a rotation underway?
Amid the rally, investors seem to be weighing cyclical stocks that could potentially do better when we return to pre-Covid days, against big tech and growth stocks that have benefited from the stay-at-home trend.
In the week after Pfizer’s electrifying announcement, energy stocks surged 16.5% and airlines gained 10.5% as investors cheered the possible return to some sense of normalcy. However, the Nasdaq closed about 0.5% down, as investors sold off tech and communications services stocks. Companies like Zoom, Peloton and Netflix – which had benefited most from people staying home – also saw their share prices sink.
Many market commentators are now saying, perhaps prematurely, that this is the start of a rotation away from large-cap growth companies and towards smaller-cap companies and more cyclically focused value sectors like energy and financials.
Why tech is not dead
It is worth noting that one or two weeks of trading might not be a good judge of any such trend in market movements. It remains to be seen if the apparent narrative that technology stocks will slow down their pace of growth while cyclical stocks will benefit from an economic reopening actually plays out.
The current economic backdrop remains favorable for many tech stocks. A complete vaccine roll-out is still months away even as coronavirus cases in the US and Europe continue to climb. The increasing restrictions to physical business activity and socialising stands to keep more people tied to tech services. Beyond that, the top growth stocks today all have relatively healthy balance sheets, positive cash flow, and resilient profits. Over the mid-to-long term, investors who prefer the relative safety of large-cap, tech-related companies are likely to continue keeping their money there.
Right now, there are not yet enough data points to support the possible conclusion that we are in the midst of a new sector rotation. In other words, there might be a palpable gap between short-term expectations and actual fundamental reality. For long-term investors, holding a diversified portfolio across sectors, and not shifting on short-term sentiment, would still be the better way to go.
No overnight recovery
While stock markets have been rallying on vaccine progress, the accelerating surge in coronavirus cases still presents a threat to the fledgling economic recovery in the US and Europe.
Cases in the US have now topped 11 million. Outgoing president Donald Trump has ruled out putting the US into lockdown, but many states are introducing their own restrictions as fast rising cases threaten to overwhelm their healthcare systems. If the situation deteriorates as the winter months approach, we could see the US economic recovery stalling.
This seems to be the current situation in Europe. Renewed nationwide lockdowns will likely lead to weaker economic activities in the fourth quarter of this year, and a possible double-dip recession in Europe.
At this time of writing, the US Congress has yet to reach a consensus on the much-needed second stimulus package. With more restrictions being imposed, thousands of American households and businesses will be left to fend for themselves without any financial assistance from the government. This is likely to further dampen US recovery prospects.
Ultimately, the Pfizer and Moderna vaccines are still months away from the start of widespread distribution. And for the vaccine to be truly useful, it needs to be administered to a large enough part of the population. This will involve efficiently mass producing and transporting the vaccine to millions of people from all around the world.
So although the vaccine optimism has been beneficial for stock markets in general, be prepared that the full economic effect of the vaccine may not be felt for at least the better part of a year or even longer.
What to look out for in the near term
With the US presidential election in the rear-view mirror, attention is now being turned to which party will control the US Senate in 2021. This has added another layer of complexity to the political calculus around a second stimulus package.
Whether the Republicans or Democrats control the Senate will be decided by a pair of run-off elections in Georgia next January. The Republicans currently hold 50 seats, compared with 48 by the Democrats.
If Democrats win both seats in Georgia, they will be in control of the Senate since Vice President-elect Kamala Harris holds the tie-breaking vote. Assuming that talks for the stimulus package stalls till next year, a win could pave the way for Democrats to advance their own $2.2 trillion stimulus plan.
But if the Republicans win even one of those seats, they retain control of the Senate. The challenge will continue to be getting House Democrats and Senate Republicans to compromise on the size of the package deal. Currently, those talks don’t seem to be getting any closer. Only time will tell if a stimulus deal can still be passed before next January.
The big picture
As markets await more positive vaccine news as well as clarity on the size and timing of a new stimulus package, what can investors do?
We would suggest thinking longer term rather than focusing on the next few months. In this current climate, headlines tend to be mercurial and can change on a dime. Investors should not rush into making portfolio decisions based on possibly short-term trends. Remember, the relative performance of certain sectors over a short period of time should not be taken as a sign to pile in.
Instead, investors should adopt a diversified approach. Their portfolio should cover broad segments of the market so that no matter which sector is outperforming during a given period, they can still benefit.
With a Biden presidency and a possibly gridlocked US government, there is a wide range of potential outcomes for policymaking and the economy. Diversification will be more important than ever to mitigate some of the risks associated with individual investments.
By Richard Yeh, Head of Portfolio Construction and Risk Management, Syfe