Nov 09, 2020

COVID Uncertainty Begins to Clear

It is not often that the election of a U.S. president is eclipsed in the news cycle. Today, however, exactly that has happened as news of efficacy results from Phase III of Pfizer and BioNTech’s COVID-19 vaccine swept the globe. 

It isn’t often that a U.S. President gets second billing, however President Elect Biden is simply the icing on the cake today. The cake, as it were, is that Pfizer and partner BioNTech made an early announcement of efficacy results from the U.S. Phase III COVID-19 vaccine study. The results were a major surprise and a major positive. Here are some highlights from the press release:

  1. The vaccine has shown >90% effectiveness in preventing COVID-19 in participants without evidence of prior SARS-CoV-2 infection in the first interim efficacy analysis.
  2. The 90% efficacy level is very strong and exceeds the 60-70% that healthcare experts were expecting.
  3. Importantly, no serious safety concerns have been observed.

Pfizer expects the Emergency Use Authorization application to be on track for the end of this month. Pfizer also expects to provide global supply for up to 50 million doses in 2020 and 1.3 billion in 2021.

The news sent stock futures soaring. The Dow, for example, was set to open about 400 points higher based on the Biden news but was 1,200 higher after the vaccine news came out. Hence why we believe that economics trumps (no pun intended) politics. Worth mentioning is that what we know about Biden’s policies thus far will generally be supportive of economic growth and beneficial for sectors like Health Care, Industrials, and Renewables. We also believe his more steady-handed foreign policy will lead to better relations with Europe and less draconian measures with China, which will be beneficial for our international portfolios.

The vaccine announcement and the prospect of growth resumption in the business cycle is what equity markets have been waiting for. This sets the stage for what could be one of the best backdrops for sustained gains we have seen in years after a prolonged period of elevated risks from Brexit, global trade war, COVID-19 pandemic, and the U.S. election. In the past, we have used the phrase “expect the unexpected” to describe events which act as catalysts, both positively and negatively. We also discussed recently the patience and perseverance required to be disciplined as we wait for an investment thesis to play out, because the timing is uncertain. A day like today is very telling because even though many investors believed a vaccine would eventually come, not many were positioned for it. We know this from today's market action. For example, while the S&P 500 equal weight index was up over 4% today, the NASDAQ was down 1.5%. Today, and we understand it is only one day, we see evidence that our patience and perseverance in holding select investments outside of certain highly valued tech names is starting to be rewarded.

Balanced Market
This signifies a more balanced market going forward. This is healthy. We’re not implying that there will be a massive selloff in high valuation stocks, or that we need one to justify our thesis. Simply, there are many low valuation stocks that we believe have no fundamental reason to stay at these low valuations.

Let us provide a couple examples. The EU banks are currently trading at a valuation of half the market, which is two standard deviations below the average going back to 2002 (Figure 1). Without going into detail here, the banks have extremely strong balance sheets. The disconnect simply lies in the uncertainty and path of the economy linked to the virus. As the COVID uncertainty begins to clear, investors begin to see the value again. The EU Bank Index was up 13% today.


Figure 1: Forward P/E of EU Banks vs EU Market

Forward P/E of EU Banks vs EU Market

Source: JP Morgan


Similar dynamics are occurring in the U.S. The correlation between U.S. banks and 10-year bond yields has been tight, but recently diverged as 10-year yields rose while bank stocks underperformed (Figure 2). Again, there is no fundamental reason why this relationship should break down other than investor perception around COVID and its effect on the economic cycle. As clarity appears around the COVID uncertainty, so does investor appreciation for risk/reward of these banks. The U.S. banking sector was up 8% today.

Figure 2: U.S. Banks Index vs U.S. 10-Year Bond Yields

U.S. Banks Index vs U.S. 10-Year Bond Yields

Source: JP Morgan

Fixed Income
We have commented on the growing disconnect between bonds and equities. In October, bonds and equities sold off, with government bonds providing no diversification benefits for holding them. We would argue that given where government yields are, the only reason for investing in them is that they provide some ballast to falling equity markets. With that correlation breaking down and more potential clarity on a COVID vaccine, government bond yields are ripe to move higher as they lose their safe haven status. For example, today the U.S. 10-year treasury yield jumped by 17%, to end the day with a bond yield of 0.95%, the highest since March of this year. In this environment, risk/reward is skewed to spread products like corporate bonds, high yield bonds and preferred shares.

Conclusion
The announcement of a U.S. Elect being overshadowed by a COVID vaccine announcement seems appropriate, given the rollercoaster that investors have been experiencing this year. It has been extremely difficult to navigate the crosscurrent of headlines that have dominated the investment landscape. Investment success requires a disciplined and patient approach to cut through the noise and understand the fundamentals of investment opportunities. Then, one must have the patience and perseverance to see it through.