As the Virus (Trajectory) Turns - February 2021

It would appear, at least from the perspective of investors, that 2021 is intent on being as memorable as its predecessor. In the first month alone, unprecedented events in the political, health, and market spheres have contributed to equity volatility. We expect this volatility could continue in the near term, particularly as many assets are trading at elevated (in some cases excessive) valuations and the short-term economic outlook remains challenged. Looking out over the next 9–12 months, however, we remain optimistic on both the economic and market fronts. Over this longer investment horizon, we expect the U.S. to benefit from further fiscal relief and ultimately to move beyond the pandemic as a durable economic recovery takes shape. It is important to note that we do not expect the market stresses resulting from concentrated speculation in lower-quality stocks to spill over to the broader market.

Virus, vaccines, and policy

The economy is still hostage to the virus, but we can see the light at the end of the tunnel. As vaccine supply and distribution continue to ramp up, the biggest threat to the recovery timeline is the mutation of COVID-19, with the South African strain presenting the latest risk to an optimistic outlook. Fortunately, recent clinical data have been encouraging even against this viral mutation.

Last week, Novavax and Johnson & Johnson revealed their Phase 3 data. While the headline numbers suggested these vaccines had lower efficacy rates than the Pfizer and Moderna vaccines (for which late-stage studies showed 90%–95% efficacy against the original virus), it is vitally significant that both recent vaccine candidates proved highly effective at preventing severe illness or death against all known strains. In addition, in the case of the J&J product, much higher shipping temperatures, easier large-scale production and the requirement of only a single inoculation, mean that the U.S. should enjoy sufficient, high-quality vaccine availability for all adults in the first half of the year. Given these considerations, we are expecting a dramatic drop in virus prevalence and a broad-based economic reopening in the U.S. in the second half of 2021. If this optimistic picture indeed plays out, and with the Federal Reserve committed to its current zero-rate policy for the foreseeable future, domestic equities have further to run, in our view.

In the interim, we expect continued near-term economic weakness in the U.S.—as evidenced by the second consecutive month of declining retail sales and a material increase in jobless claims. Yet another round of fiscal stimulus—that we believe will most likely come in north of an additional $1 trillion—will help bridge the gap until the virus wanes. Importantly for investors, the market reaction to additional stimulus may be a function of the legislative path taken. Specifically, if Democrats in the Senate cannot remain united and also garner support from at least 10 Republicans, they will be forced to go the route of budget reconciliation. As many of you may recall, this was the means by which Republicans passed tax cuts in 2017, as it requires only a simple majority in the Senate. The catch is that this process is more limiting in the items that can be included (they must be budget related) and any spending must be offset somehow to create budget neutrality over the 10-year budget window. That means higher taxes as early as 2021, likely sooner than many market participants anticipated.

Please see important disclosures at the end of the article.