November 9 , 2020 – Election certainty and news that Pfizer’s Covid-19 vaccine candidate is 90% effective have investors euphoric this morning. The vaccine news suggests that an end to the pandemic is in sight although it is still premature to throw away our masks. The key to the stock market next year however may not be earnings, which are certain to recover, but the path of interest rates.

Stocks had big gains last week as it became increasingly likely that Joe Biden would be the next President of the United States.  While the results won’t be complete until certified by the states, and President Trump is planning to file legal challenges, almost everyone now accepts the results.  This morning, as a first step, President-elect Biden is expected to announce his Covid-19 task force.  That announcement is likely to be overshadowed by news this morning that Pfizer’s vaccine in development has proven so far to be 90% effective.  That is quite a bit above consensus expectation and is creating a market surge this morning.

A sober look at the vaccine news still leaves unanswered questions about the number of doses immediately available, further steps necessary for approval, and the fact that about half of all Americans say they won’t take the vaccine anytime soon until they are convinced that it is absolutely safe, effective, and durable.   But what people say and what they do are different.  For instance, if there is a large surge, like what is going on in Europe at the moment, the number willing to get vaccinated will rise.   In addition, behaviors will change knowing there is a vaccine.  People will be more willing to fly, eat in restaurants, and otherwise participate in normal activities.  This applies equally to those who take the vaccine and those who don’t.  Younger folks who don’t fear the virus will fly regardless, especially if activity is unrestricted.   Those older and more apprehensive will most likely take the vaccine.

The vaccine won’t be widely available for some time.   Pfizer’s vaccine may not prove to be the best or the safest over time (although no safety issues have appeared to date among more than 23,000 enrolled in its clinical trial who received the vaccine).  There are significant logistical hurdles.  The vaccine must be kept frozen or refrigerated until use.  It will have a very limited shelf life.  All this suggests it will still be several, perhaps many, months until a vaccine is widely available.  But with all the warnings and asterisks, this is big news.  There is light at the end of the tunnel.  Nothing is going to change the next few months.  We can’t throw our masks out.  But we can plan a cruise next fall.  The NFL in 2021 can have a normal season with fans in the stands.  There is an end, and that is what markets are celebrating this morning.

 

Once the euphoria dies, we will again have to focus on the numbers.  Remember, stocks care about earnings and interest rates, not election legal battles or how many people are infected.  The news that we are likely going to get a vaccine soon means:

1. More economic certainty, especially beyond mid-2021. That’s good news.
2. A more defined economic recovery path for those caught in the eye of the storm. That includes all the obvious travel and leisure stocks. They will rally strong today.  However, many companies are burdened with extra debt necessary to stay alive and some (think movie theatres and gyms) may be victims of life patterns that have changed. With that said, earnings recovery in 2021 and 2022 may be faster than previously thought.  I doubt however, that many earnings forecasts outside of the travel industry will change quickly as a result of the virus news.
3. Interest rates could rise quicker as faster activity stimulates more inflation. There is an immense amount of slack in the economy and an awful lot of money sloshing around.  Office buildings will remain empty for a long time, and oil inventories will remain high.

 

The net result could be mixed.  Higher earnings will be offset by lower P/E ratios.  Unlike past recessions, markets are at or near record high levels today.  This isn’t 2009 redux.  Markets have been seeing through the virus surge for some time.  A vaccine helps, but remember that in the last 20 years when earnings rose by 15% or more, stocks fell 9 times.  Earnings alone don’t matter.  Interest rates and P/Es matter as much.  The Fed right now feels there is so much slack that accelerating economic growth has to eat through all of that excess capacity before inflation fears will evolve.   That may prove correct.   We know that for the past many years, including all of the years mid-decade, when central banks were invoking quantitative easing programs to support economic growth, the recipients of the newly created money invested it rather than spent it.  This inflated asset prices, not the CPI.  No one yet has an answer to the obvious.  What if emboldened spirits decide it is time to spend rather than invest?  The Fed says it will tolerate inflation well past 2% for some period of time.  We’ll see.

The combination of election certainty and the emergence of a vaccine should lead to lower volatility.  It also supports less fear for the economy’s weakest sectors, those that have been left behind in 2020 rallies.  But the big question today is whether the rallies that we are likely to see are enduring.    Will the yield curve steepen enough to help the banks?   Will enough people get on a plane soon enough to stop the cash burn at airlines?  Lest we forget, overcapacity isn’t just a 2020 issue.  It simply has been aggravated by Covid-19.  There were too many retail store fronts before Covid-19.  Now there are way too many.

Of course, there is a flip side to this.   Is Zoom a permanent part of our lives?  Are we still going to buy Peloton bikes when gyms reopen and fears fade?  I suppose the answer to both is yes, but the amount of Zoom usage and the pace of buying home exercise machines will change.  Life is never going to be the same.  Work from home, where practical, will be more prevalent.  Home delivery or curb pick-up isn’t going away.  Migration to the cloud isn’t going to slow down.

 

Finally, let’s not forget that we are staring at a new Presidency in about two months.   While the outcome in the Senate isn’t certain, it is fair to make a few conclusions:

1. The chaos that characterized the Trump administration will fade. Predictability will rise.
2. Biden’s first two tasks are to lessen the impact, as much as the government can, from Covid-19, and to pass what may be a final stimulus bill to provide a better safety net for those businesses and individuals most impacted by the virus’s impact.
3. He will attempt to reach across the aisle and find some common ground, a step to start a healing process. It takes two to tango and we have no idea how far this will go, but it is fairly certain that an attempt will be made.  There are a lot more Senators and Congressmen who want to find common ground than you might think.
4. In my head, the big loser of this election was the progressive wing of the Democratic party. That doesn’t mean its impact will fade. It could be as disruptive as the Tea Party was a decade ago.  But the election made it clear that the core of America is in the political middle and wants to stay there.  The conservative media tried to tie Mr. Biden to the progressive wing’s agenda but it didn’t work. While Biden may try to do something tax wise, perhaps combining it with an infrastructure package, major tax increases are off the table right now and Biden knows it.

In conclusion, markets like a calmer atmosphere, the likelihood that an evenly split Congress won’t do anything rash, and that an end to the Covid-19 pandemic is in sight.  As investors, after today’s euphoria blows over, it won’t be earnings, it will be the path of inflation expectations.   However, any spending pattern changes in the months ahead, if at all, will be key to the future direction of the stock market.  The period between now and year end should be a very good time for stocks.  There is a lot of good news to chew on.

 

Today, Lou Ferrigno, the Incredible Hulk, is 69.

 

James M. Meyer, CFA 610-260-2220