Has the COVID-19 vaccine made the market irrationally exuberant?

12/9/20: Maybe it’s lockdown fatigue, but it appears virtually every risk market has been on fire since news of effective vaccines hit the news a little more than a month ago. Retail investors, who swapped sports betting for stock trading, were joined by institutional buyers last month. Globally, investors ploughed more than $90 billion into equity funds since the beginning of November. The MSCI All-Country World Index surged more than 12 per cent in November in response, its best monthly showing on record. The rally was fueled by sectors, including airlines, hotels and energy companies, that were left behind during the pandemic. The steady stream of positivity, both in the markets and in the headlines, have helped pump up investor optimism. Expectations running this high are prone to disappointment.

That’s because investor sentiment, a measurement of investors’ emotions, is a contrary indicator; the more optimistic it ranks, the more bearish it is. That’s because the market, at least over the near term, reflects the convergence of reality and expectations. Optimism carries high expectations, which raises the prospect of disappointment. History has shown that six-month and one-year S&P 500 returns are, on average, twice as high when preceded by extreme bearishness than they are when preceded by extreme bullishness. Investor bullishness is currently situated near an historical peak, according to a weekly survey conducted by the American Association of Individual Investors. Investors are rightfully optimistic, thanks to the vaccines and the prospect of a return to normalcy in the back half of next year. The first two quarters of 2021, however, could test investors’ enthusiasm.

Beginning in early October, the US, like Europe, entered a third wave of infections. America’s average daily caseload of 150,000 is more than three times greater than the surges we suffered in both March and June. The trend has prompted alarm in medical leaders and policymakers. Dr. Deborah Birx, the White House Coronavirus Response Coordinator, warned on Monday that the vaccine – which could receive FDA authorization as early as this week – while crucial, will not be able to protect Americans from the current spike in COVID-19 cases across the country. COVID-19 has now topped heart disease as the leading cause of death in the United States, according to The Institute for Health Metrics and Evaluation at the University of Washington’s School of Medicine.

Governments in Europe, the UK and several US states are responding with new rounds of measures to curb the spread of infections, closing schools to in-person learning and restricting indoor service in bars and restaurants. A new wave of lockdowns and restrictions will crimp economic growth while taking a further toll on out-of-work individuals, struggling small businesses and municipalities.  More than 23 million Californians are currently living under stay-at-home orders, as COVID-19 cases hit record levels there recently.

State and local governments face shrinking tax receipts and billions of dollars of shortfalls. This situation is forcing city leaders to consider devastating budget cuts that threaten to cripple public services, reduce the ranks of police officers, close libraries, reduce childcare support and shutter drug treatment centers. The fallout would, among other things, add further to the 1.3 million jobs already lost due to the pandemic. A recent survey cited by The New York Times showed that 45 per cent of mayors expected to make “dramatic” cuts to their school budgets. Transit systems across the country are sustaining service cutbacks. Boston is considering ending weekend service on commuter rail and shutting down the city’s ferry service. Atlanta suspended 70 of its 110 bus routes, a move that could become permanent. New York City, home to the largest mass transit system in North America, plans to slash subway service by 40 per cent and cut commuter rail service in half, according to The New York Times. With ridership and fare revenue plummeting, New York’s MTA is bracing for a $6 billion deficit next year, while Boston and Chicago have forecast $600 million and $500 million shortfalls, respectively.

Federal Reserve Chairman Jerome Powell warned that state and local spending reductions will weaken the recovery, recognizing that state and local government spending accounts for 15 per cent of America’s economic activity. While the federal government has the luxury of running deficits from year to year, states don’t enjoy the same financial flexibility. The problems are bipartisan. Red Florida and blue Nevada, both reliant on tourism, will suffer revenue declines of 10 per cent or more. Wyoming, Alaska and North Dakota, Republican-led states which depend on energy-related taxes, have been hammered by a sharp decline in oil prices. New York, California and Illinois endured an exodus of workers from their downtown business districts.

The global economy is expected to limp into the new year. The International Monetary Fund (IMF) estimates world growth will shrink 4.4 per cent in 2020. That would represent its steepest annual slide since the Great Depression. But the IMF is also forecasting a 5.2 per cent expansion in 2021, with most of the growth concentrated in the second half of the year. The most recent jobs report fell short of expectations, as employers added 338,000 additional jobs in November after excluding layoffs associated with the end of the census. Hiring in delivery and warehousing was offset by net losses in retail, restaurants, schools and banking. Economists worry that without another round of fiscal stimulus, job growth could reverse.

Efforts to pass a $900 billion bipartisan stimulus plan – which includes $160 billion for state, local and tribal governments – appears to have stalled. Two issues are inhibiting its passage. State and local support is a stumbling block for Republicans, who argue that spendthrift municipalities don’t deserve a bailout since they faced financial challenges long before COVID. Democrats resist absolving private businesses of COVID-related liabilities, particularly those who failed to maintain safe conditions for their employees and customers. Meanwhile, the $1,200 stimulus checks progressives pushed for are not included in the bipartisan framework, since its estimated cost is between $300 and $500 billion.  Keeping the cost of the program below $1 trillion is critical for Republican support. Despite the periodic optimism that a compromise will be reached, we don’t expect the support measure to pass until after January 5, when Georgia holds its special runoff election and control of the Senate is determined.

The next few months will be a challenge, as rising infections, expanding lockdowns, delayed stimulus and disappointing economic data could test investors’ bullish resolve. But investors are right to be optimistic. The prospect of normalcy is uplifting, even though it is more than six months away. Equity investing is always forward looking, often more than two quarters out. S&P 500 earnings are expected to grow by more than 24 percent in 2021. Markets measure aggregates – but, this time around, aggregates don’t tell the whole story.


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