Can vaccine hopes drive equities higher?
Will the momentum behind equity markets hopes on a COVID-19 vaccine sustain elevated valuations, or will reality kick in soon?
- Equities recent strength seems to rely on hopes of a vaccine. Even if one is soon, it may not lift growth quickly
- Any excitement about potential government spending plans on infrastructure projects should be tempered
- The narrow market leadership among Tech stocks suggests little irrational exuberance exists among investors, though there are risks
- It may be time to be more selective in the regions, sectors and stocks being targeted.
Despite many local spikes in COVID-19 infection levels being seen in North America and Europe, equity valuations have been extremely resilient since March’s sell-off. While hope can be a strong force in financial markets, investors’ seeming belief in a quick economic recovery and COVID-19 vaccine being found relatively soon may soon face a day of reckoning.
Finding a vaccine is the first challenge. One that could take several months or years. Factor in the expected gap between finding a vaccine and immunising populations and the timeframe lengthens. Investors should not expect a vaccine to quickly accelerate economic momentum significantly.
Skyrocketing government spending
The level of support provided by governments to shield the economy from much of the effects of the pandemic has been massive. Investors expect administrations to maintain some level of support to help businesses through the pandemic.
The prospect of large infrastructure spending plans by governments as part of the pandemic economic recovery package seems to excite many investors in Europe and North America. However, caution may be called for. Even if the plans see the light of day, they are unlikely to help lift activity before 2022 at best.
Central banks join in
Central banks have joined the pandemic support efforts, intervening like never before through low interest rates and more quantitative easing. Such aggressive policies seem set to be active for several months, if not years.
While it now appears that there is virtually no limit to authorities’ interventionism, both the US Federal Reserve and the European Central Bank seem willing to “wait and see”. Investors may eventually get what they want in the form of looser policy, this might not happen until there is a sustained fall in equities or financial conditions tighten too much. Reassuringly, the performance of various asset classes and equity sectors suggests that a strong recovery is not being banked on.
Beware crowded Tech trades
The strong recovery in equity prices since March, belies the narrowness of the rally in terms of the number of stocks driving the performance: the rally has been driven almost exclusively by a handful of “growth” companies with resilient earnings and limited correlation to the worsening economic backdrop. By contrast, more cyclical groups, such as banks or industrials, which tend to perform well in the recovery phase of the economic cycle, lagged in July.
While the narrow market leadership encouragingly suggests little irrational exuberance exists among investors, in turn it poses downside risks should the trend reverse. It could be time to take a more prudent, cautious approach and be more selective in the regions, sectors and stocks being targeted.
More diversified, quality portfolios
Diversifying away from crowded trades, such as technology stocks, to find high-quality and under-owned securities. Rather than tweaking portfolio allocations between value and growth or cyclicals and defensives, a focus on quality is about looking for businesses with solid balance sheets, attractive cash flow and sound growth prospects, irrespective of sector. As such, and with volatility and return dispersion between assets likely to be relatively high, upping exposure to actively managed assets and private markets in attempting to lift returns has attractions.
Investments can fall as well as rise in value. Your capital or the income generated from your investment may be at risk.
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