February 2021 Financial Markets Update

Macro overview

Priced for vaccination

The outlook at times seems binary: vaccination or bust

2021 is off to a muddled start. Stock markets swooned in early January before finding their footing and rallying in unison with the S&P 500 reaching fresh record highs by mid-month. WTI surged above US$53, and the Loonie traded to its best levels since 2018. Everything was moving in the right direction, and an explosive post-COVID recovery seemed assured and right at our fingertips.

In the past two weeks or so, reality has struck with its usual force. Vaccine supplies have become scarce. Logistical rollouts have been bottlenecked to the point where vaccine nationalism is now a thing. And stock markets were seemingly turned on their head as bands of retail traders took on the hedge funds and won the day. Is this the start of another bout of extreme volatility across assets?

The strong trends in place throughout Q4 2020 are being tested–it’s nothing catastrophic at the moment, but certainly the trend of risk assets rallying in uniform fashion seems a bit tired and out of place at the moment. And perhaps it should.

If Israel is any indication, we still have a long fight ahead of us and the path won’t be linear. Israel has vaccinated by far the largest portion of its population of any country to date–a full 53% have received at least one dose compared to about 9% for the US and a paltry 2.5% for Canada. And yet even at that pace, lockdowns are still required. The newer COVID variants move faster. Faster than the needle and faster than our manufacturing and supply chains. And ICU availability still rules the day with regard to the policy response.

Early efforts will pay-off, but we may not see the immediate benefits until at least the Spring. However, there are some green shoots to take note of. JP Dore, Markets Analyst is optimistic on the outlook despite the challenges in front of us. 

Reasons for optimism

Improvement in hospitalization and case rates

It has been about 25 days since the US started to administer vaccines and there are some positive takeaways even though they are minor. In the US, we note a distinct drop in the hospitalization rate as well as the number of people on ventilators. New daily case rates are also declining in a rather sharp fashion. Most encouragingly, deaths in long term care facilities, which have received a higher rate of vaccinations than the general population, have improved. And that last point is excellent news–there are fewer vulnerable people exposed to severe health outcomes which is one of the keys that must be achieved before re-opening on a larger scale. This data points to an improving trend–but as you can see the starting point was very dire to begin with, and thus there is a lot of work yet to do. 
 

Reasons for caution

Vaccination rollouts have been very slow in some countries (but the US is on track)

Even for developed countries, the differences in vaccine availability are stark. Canada may have “secured” the most doses per capita amongst our peers, but we don’t have any manufacturing capabilities and thus are dependent on others to honour commitments. This nebulous arrangement finally came to its logical conclusion last week when the EU effectively rolled out vaccine nationalism: Doses are now prioritized for EU member states ahead of exports. 

Regardless, distribution has been slow and questions remain regarding efficacy against the newer variants with J&J’s iteration only proving 66% effective against the South African strain–far below the ~90% threshold from earlier Pfizer and Moderna versions. Yet if we extrapolate the current run rate for shots delivered in the US, by the beginning of September at least one shot will have been administered to 83% of the population. The pace could increase, or it could slow, or the shots could prove less effective. A lot has to go right. Given the current pace of administration, and the current range of variants, the US is on track to achieve herd immunity by late Q3/early Q4. 

Conclusion: Priced for vaccination with little room for error

Global growth could be set for take off

This leads us to conclude that the outlook is positive. PMI’s (purchasing manager’s index) are pointing to an expansion of activity, employment trends are improving, and demand for commodities remains high. China’s latest 5-year plan, the 14th iteration, could be one of the most forceful for global growth since the early 2000’s. The trend towards urbanization is not complete with the government targeting 80% urbanization over the next 15 years compared with 60% at present. Record fiscal and monetary stimulus have the ability to pull up incomes for the middle class, which on balance will lead to greater aggregate demand in the coming years, especially for commodities. Yet there are risks. 

As equity markets pay for future performance and at current 22x forward earnings, there is   little room for error. Earnings will have to surprise to the upside for the rally to extend. And what if the Fed removes stimulus sooner than currently anticipated? That could lead to a rather forceful repricing. But the green shoots from early vaccination results and trajectories for herd immunity give us reason for optimism.