The Battle of the Vs: Virus Versus Vaccine
On the December PGIM Global Partners CIO call hosted by QMA, chief investment officers and senior investment professionals from PGIM's international businesses, PGIM Fixed Income and QMA discussed the outlook for markets and the global economy to year end and the prospects for 2021. In the near term, the battle of the “Vs,” the tug of war between virus and vaccine, is likely to be the dominant theme as the positive news about vaccine development is offset by the second wave of the Covid-19 virus with rising infections, hospitalizations and deaths and the attendant risks to economic activity.
A successful vaccine has been developed in record time, less than one year. The previous record for the fastest time to develop a vaccine occurred in the late 1960s when it took four years to develop a vaccine for the mumps. Currently, three firms, Pfizer/BioNTech, Moderna and AztraZeneca reported that their vaccines showed over 90% success in final clinical trials. The FDA is likely to approve the Pfizer/BioNTech and Moderna vaccines in in December. Based on comments from the European Commission President, the European Medicines Agency is likely to authorize the three leading vaccines by year-end. The UK became the first country to authorize the Pfizer/BioNtech vaccine, and the companies have said that they are ready to deliver the first doses to the UK immediately.
QMA Portfolio Manager Ed Keon, Robert Tipp, chief investment strategist at PGIM Fixed Income, and Ellen Gaske, PGIM Fixed Income’s lead economist for G-10 countries, all agreed that the vaccine progress was a significant positive development, though there are still questions about FDA approval, mass production, storage and distribution. However, Goldman Sachs, in a recent report, said its baseline forecast "is that large shares of the population are vaccinated by the end of Q2 2021 in all major DMs [developed markets]. The UK is expected to vaccinate 50% of its population in March, with the US and Canada following in April.” According to the Goldman forecast, “the EU, Japan, and Australia reach this 50% threshold in May. As production becomes abundant by mid-Q2, vaccination rises gradually with demand and surpasses 70% across all DMs in the fall when children become eligible." Hence, markets seem to be optimistic that the end of the Covid-19 pandemic and a return to normalcy is a now matter of months, not years.
However, the vaccine optimism is tempered by concerns about rising virus cases, hospitalizations and deaths. The current wave of infections has prompted renewed lockdowns and restrictions on activity in the US, Europe and several other countries. Consequently, after the strong GDP rebound in Q3, economic activity is on track to slow in Q4, and the weakness is likely to drag into Q1 2021 as the vaccine is unlikely to be widely distributed until mid-2021. US GDP growth is expected to moderate into the 3%-to-5% range in Q4, but, as Gaske noted, there are risks to Q1 growth, namely lingering effects of the lockdowns and winter seasonality. In Europe, growth is expected to dip back into negative territory in Q4, and Gaske is looking for a W-shaped recovery in Europe.
Given the vaccine-virus cross currents, the big question, according to Keon, is whether the US Congress can agree on a stimulus package, which could provide a financial bridge into mid-2021 by which time a sufficiently large number of people are vaccinated. There appears to be some chance of a stimulus package of between $500 billion and $900 billion, which could help the nation get through the next few months before mass vaccinations.
Looking beyond the vaccine-virus cross currents in the near-term, the December call participants expressed optimism about prospects for a solid economic rebound in 2021, with easing of political uncertainties, pent-up demand unleashed by the reopening of economic activity, strong tail winds from fiscal and monetary stimulus and low interest rates. The economic recovery and strong earnings rebound are expected to fuel solid stock market gains in 2021.
The end of US political uncertainty and prospects for a divided government mean some of the less-market friendly parts of the Biden agenda, like tax hikes on individuals and corporations and regulatory overreach, are unlikely. Another near-term positive is the easing of Brexit uncertainty, with increased odds of a last-minute UK-EU deal, which could avert a “hard” Brexit.
The Global Economy Poised to Rebound
With vaccine approval, production and mass distribution in the offing, economies are on track to reopen and normalize. Given pent-up demand, the global economy is slated for a robust rebound in 2021. Fresh fiscal stimulus and further monetary stimulus is likely to provide fuel for the recovery. While a divided government means fiscal stimulus in the US is likely to be more modest than under a “Blue Wave” scenario, fiscal stimulus in Europe, Japan and several emerging markets economies is likely to be significant. Paolo Mazzocca, an analyst at Pramerica Italy SGR, pointed out that the Italian team is looking for further fiscal stimulus in 2021. Seiji Maruyama, the chief investment officer of PGIM Japan, indicated that the Suga administration is compiling a third supplementary budget to finance fresh economic stimulus, so the Japanese recovery would not lose steam amid the fresh wave of COVID infections. The recovery is also likely to be supported by low interest rates. Tipp expects the US 10-year yield to remain in a 0.7-1% range and yields in Europe, Japan and other markets to remain around current lows.
Global GDP growth is expected to be in the 5%-to-6% range in 2021 after contracting around -4% in 2020. The US economy is expected to fire on all cylinders with solid consumer spending, a rebound in capital expenditures, red-hot housing and inventory rebuilding. With the economy growing at a solid, above potential pace, job growth should continue and unemployment should decline, reducing the slack in the labor market. Gaske’s forecast is for US GDP to grow around 4.5% in 2021, with risks to the upside. This is above the consensus forecast of around 4%, after contracting around -3.5% in 2020. Gaske also anticipates that as the vaccines are rolled out, there is likely to be a rotation from spending on goods to increased expenditures on services, boosted by pent-up demand for services.
Among other countries/regions, Eurozone GDP is expected to grow around 4.6% in 2021 after the sharp -7% contraction in 2020. Given the deep hole in 2020, Mazzoca and the Italian team expect the Eurozone economies to return to pre-COVID-19 levels only by 2022. The UK economy, which suffered one of the sharpest declines in 2020, with growth estimated to have contracted by -11.2%, is on track to a strong rebound in 2021 with over 5% GDP growth. The Japanese economy is expected to grow by around 2.5% in 2021. In China, the first country to recover from the pandemic and the only country to post positive growth in 2020, around 2%, growth is expected to strengthen further in 2021 to around 8%. Bevan Yeh, the equity chief investment officer at PGIM SITE expects Taiwan’s economy to grow around 4% in 2021. PGIM India’s chief investment officers, Srinivas Ravoori and Kumaresh Ramakrishnan, expect India to re-emerge as one of the fastest-growing emerging markets, with a double-digit GDP rebound in 2021 after contracting -9% in 2020.
Strong Earnings Rebound
After the collapse in corporate profits and earnings in 2020, and with GDP growth on track to a solid recovery in 2021, corporate profits are expected to rebound sharply. Consensus forecasts are for S&P earnings per share to grow between 25% to 30% in 2021, to around $175, after declining around -15% to $136 in 2020.
Earnings for Eurozone companies are expected to rebound around 50% in 2021 after the sharp -37% decline in 2020. Japanese earnings are on track to recover around +43% in 2021 after a relatively modest -9% decline in 2020. Emerging markets (EM) earnings expectations for 2020 have been improving to a modest -8% decline for 2020. EM earnings are expected to rise 32% in 2021.
The strong earnings recovery is likely to drive equity market gains in 2021 after P/E multiple expansion lifted stocks higher in 2020. Given the 2020 gains, stocks are currently on the expensive side, as P/E multiples have risen given the strong price gains and decline in earnings. Hence there is less scope for multiple expansion, and robust earnings growth is expected to fuel the rally in 2021.
The equity rally in 2020 was driven largely by stay-at-home stocks and growth sectors. Region-wise, the US, and tech-heavy Asian EMs, China, Taiwan and Korea, posted strong gains in 2020, while Europe, Japan and cyclical-oriented emerging markets lagged. In 2021, stock market gains are likely to broaden across sectors and regions.
The Bottom-line
After struggling in September and October, global stock markets enjoyed a strong rally in November with easing of US election uncertainty and significant progress on the vaccine front. The rally was broad-based with big gains in cyclical and value sectors and regions, and small caps.
With Santa Claus arriving early this year, the December CIO call participants discussed the outlook for markets and the economy to year-end 2020 and the prospects for 2021. With US election uncertainty largely over and a divided government more likely, the tug of war between the vaccine and virus is likely to be the key determinant of the market trajectory to year-end and in early 2021.
Looking beyond the near-term vaccine-virus cross currents, the December call participants expressed optimism about prospects for a solid economic rebound in 2021 with easing of political uncertainties, pent-up demand from reopening of economic activity and strong tail winds from fiscal and monetary stimulus and low interest rates. The robust economic rebound and strong earnings growth are expected to fuel further, broad-based stock market gains in 2021.