The U.S. elections and a Covid-19 vaccine breakthrough have provoked an upheaval in capital markets. Euphoria prevails, with foreseeable pitfalls.
- With regard to the U.S. elections, the market has shown remarkable flexibility, finding positives in a scenario it previously viewed as bad.
- With markets already buoyant, surprise positive vaccine news added to the euphoria.
- Overall, two areas of risk appear to have been significantly defused, and euphorically celebrated. From a one-year perspective, we believe there is further potential, as long as interest rates stay tamed.
Many investors have enjoyed the start of November a lot, with capital markets suddenly in “risk-on” mode. On Tuesday morning, Europe’s stock markets are ahead by an average of around 15% so far in November, compared with less than 10% in the United States. The biggest boost came on Monday, from positive news on a Covid-19 vaccine. Particularly striking on Monday was strong sector and theme rotation. Value stocks rose almost five times as fast as growth ones (whereas growth stocks were in strong demand immediately after the election). And with expected winners and losers from lockdowns, the picture was similar.
The rally since the beginning of this month has more than compensated for the market weakness since mid-October, with the MSCI AC World Index trading at a historic high intraday on Monday. For bonds, reactions were more mixed. While U.S. government-bond yields fell shortly after the election, they soared to just under one percent on Monday, while German Bund yields began the month with little change before also rising significantly. Meanwhile risk premiums on corporate and European periphery bonds narrowed sharply. Since the beginning of the month, the dollar has been weaker against currencies of major trading partners (for example against the Japanese yen and South Korean won) and stronger against the euro.
U.S. election results
In our opinion the market reaction to the U.S. election once again showed what an unreliable political barometer the stock markets are. At the beginning of the year a victory by Trump was supposedly investors’ preferred scenario but this idea gave way to a feeling in the summer that a clear victory for the Democrats (a Blue Wave, i.e. also the takeover of the Senate) was likely, and would have its pros and cons. In the aftermath of the election, however, investors showed themselves to be flexible again, celebrating a result that they had previously viewed as the worst outcome: a narrow, contested victory, and with power shared between Congress and the White House. At this point, however, we assume that Joe Biden’s victory is undeniable, while in the Senate the Republicans will likely retain their majority by a narrow margin. It could, however, take until January 5 (probable Georgia by-elections) to confirm this. In Congress, the election has rather strengthened the political center, which should allow an experienced politician and bridge-builder like Joe Biden to reach cross-party compromises. However, the Democrats’ boldest plans, for example, removal of most of President Trump’s tax cuts, are likely to be off the table.
For the global pandemic, important news came from a site only about 40 km from DWS’s Frankfurt headquarters. A young company together with its partner, a multinational U.S. pharmaceutical company, announced a breakthrough in Covid-19 vaccine development on Monday. The vaccine showed an efficiency of “over 90%,” according to a press release. Previously, the market had expected much lower levels, with efficiency rates of around 50%. Approval is expected to be granted this month, with up to 50 million units to be distributed to select recipients this year. The aim is to deliver 1.3 billion units in 2021, mostly towards the end of the year. Encouragingly, other companies that share the same technology are also making good progress in developing a vaccine. Of course, there remain difficulties and uncertainties. The vaccine has to be transported and stored at minus 70 degrees Celsius and its effectiveness for specific sub-groups and how long it remains effective are still unclear. Reliable data on side effects should be available in the third week of November, and data on efficacy, in line with U.S. regulatory authorities’ protocol, in December. Other open questions remain the willingness of the population to be vaccinated with a first-generation preparation (Deutsche Bank Research estimates a range from 34% to 61% for individual countries), and whether the prospect of a vaccine may cause populations to cease to take Covid-19 precautions, with potentially negative consequences.
Impact on asset classes
We do not yet know how substantial and lasting the impacts from the U.S. elections will be on asset classes. The political agenda is still too vague. Also unclear is to what extent asset classes may have already priced in future policies. But the news on a new vaccine is certainly positive. We will examine how much this could bolster economic recovery in 2021 and the impact on individual asset classes in more detail later this week as part of our quarterly strategy meeting. From a macroeconomic perspective, we had expected a difficult first half of 2021 and normalization in the second half. The vaccine news, we believe, underpins our assumptions.
From a capital-market perspective, weighty uncertainties certainly seem to have been resolved. There was no immediate unrest around the U.S. elections and the risk that U.S. bond yields will soar seems lower given that the Democrats did not achieve a clean sweep and will not likely have a free rein with their stimulus plans. This is already reflected in a sharp drop in volatility in many asset classes, with the CBOE Volatility Index (Vix) in the U.S., for example, falling from 40 to 25 points at the turn of the month, not far from its lowest point for the year, at 20. However, we believe equity investors should not overlook the complex interaction between the vaccine news, economic recovery, central-bank interventions and interest-rate levels. Especially since mid-2019 the increase in equity valuations has paralleled the course of real interest rates. Now it is possible that the economic outlook is slightly improved. But we believe it is also possible that bond yields move a little higher, which may challenge equity valuations. Previously we had a moderately positive 12-month outlook for equities and corporate bonds, as well as selected emerging-market bonds. We will evaluate in due course if the term “moderately” has to change. For now there seems little to stop markets’ new found enthusiasm.
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Originally published by DWS, 11/10/20
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