17 Nov 2020
Positive news on Covid vaccines gives us greater confidence that the economic restart can re-accelerate in 2021 – and that the cumulative activity loss from the virus shock will ultimately be a fraction of that seen after the global financial crisis (GFC). We prefer to look through any market volatility generated by the virus resurgence and renewed restrictions over the challenging months ahead.
Vaccine development
Positive Covid vaccine developments give us greater confidence in the activity restart, and may make it easier for policy support to bridge the income gap.
Market reaction
The vaccine news sparked a sharp rotation into value and small-cap stocks that fizzled later in the week when near-term virus concerns returned to the fore.
Data watch
China’s industrial output data this week will likely confirm the ongoing recovery while US data may not yet reflect the recent worsening in virus dynamics.
Chart of the week
US GDP shortfall from the GFC vs. estimated loss from the Covid shock
Sources: BlackRock Investment Institute, with data from Reuters News, November 2020. Notes: The green line shows the cumulative sum of the difference between actual US GDP and where it would have been had it grown at its pre-GFC trend level (3.4% a year in nominal terms) from 2007onwards. The solid yellow line shows the total shortfall of US GDP over two years from the last quarter of 2019, based on the median expectation from a Reuters poll of economists published on Sept. 25, 2020. The solid orange line shows our estimate for a hypothetical scenario of renewed tightening/lockdown measures. We assume trend growth after the two years, shown as the dotted lines. For illustrative purposes only. There is no guarantee that any forecasts made will come to pass. The hypothetical scenario is subject to significant limitations as the pandemic is evolving and we are still trying to understand the potential for more extensive activity shutdowns.
Traditional business cycle analysis doesn’t apply to the Covid shock, in our view. We see the latter as more akin to the shock of a natural disaster: With the vaccine news, we have even greater visibility on how the cumulative activity loss will likely be limited – just a fraction of that seen after the GFC in our estimate - even as we expect a renewed surge in infections and resulting restrictions to disrupt the restart in the near term. See the chart above. We are still months away from any vaccine being widely available. But the game changer is that we now know we are building a bridge to somewhere, providing more clarity for governments and companies about getting to the post-Covid stage. That will make it easier to absorb any near-term disappointments and have greater confidence in the restart plan. It should also help limit any economic scarring and justify deploying further policy support. Yet risks of retrenching fiscal policy too soon, especially in the US, look to be significant. Still, we see the vaccine development providing a constructive backdrop for risk assets as we approach 2021.
BlackRock’s portfolio managers and senior executives gathered virtually last week at our 2021 Outlook Forum to discuss what we see as a new investment order. The pandemic has accelerated transformations in our economies and societies across four dimensions – sustainability, inequality, geopolitics and the policy revolution. A tectonic shift toward sustainability was already under way, and the pandemic shone a spotlight on some underappreciated environmental, social and governance (ESG) factors such as employee safety and supply chain integrity.
The pandemic is also accelerating geopolitical trends that were already in motion – such as the shift toward a bipolar US-China world order and a remapping of global supply chains. A simple way to think about it: The global economy is recalibrating from a single-minded focus on cost efficiency and short-term profitability to a system that puts greater weight on long-term resilience. Reduced global specialisation could result in higher production costs, in our view.
The inflation outlook was at the center of our debates. The pandemic has spurred new structural trends such as a policy revolution that sees greater coordination between fiscal and monetary policy. Central banks are showing an increased tolerance for inflation overshoots after persistent inflation undershoots, and the fiscal-monetary coordination is leading to political pressure to keep interest rates low even amid rising price pressure. Together with rising production costs stemming from the remapping of global supply chains and more focus on sustainability, this points to a higher inflation regime over the medium term. This is a shift that markets are not prepared for, even though in the near term corporates’ cost-cutting effort may help mitigate some price pressure.
Investors need to adapt their portfolios to these accelerated trends, including higher inflation in the medium term. These views reinforce our strategic underweight in nominal bonds and preference for inflation-linked debt, as well as our belief that allocations to Asia’s growth engine and private markets will be crucial for delivering real diversification in the post-Covid world. We also favor sustainable assets as we see sustainability becoming the fundamental source of portfolio resilience. Even with a vaccine on the way there are major sectoral implications as the Covid shock creates structural winners and losers. We see big tech companies likely maintaining their high margins under a divided US government and airlines among the potential losers as business travel recovers only slowly. Stay tuned for our 2021 Global outlook.
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