As we round out an eventful year, we anticipate positive vaccine developments will be a ‘game changer’ for financial markets over the coming months. With at least one candidate vaccine now approved for emergency use in one part of the world, a key question now is: when will the world achieve herd immunity, thereby allowing the global economy to re-open? There are two main challenges from regulatory approval to the achievement of herd immunity:
- The first is the manufacturing and distribution of a vaccine. While developers have geared up for large-scale manufacturing, 85% of the initial production volume has been reserved by major developed economies. From here, a vaccine would likely be distributed to priority groups before broadening out. In the UK, that’s healthcare workers, the elderly, those most at risk and their carers. This suggests herd immunity may be achieved in developed economies by the end of next year. Less developed economies are unlikely to gain access to a vaccine as quickly, with the exception of China and Russia. Herd immunity for these economies will likely come later, possibly around mid-2022.
- The second challenge is the willingness of the population to be vaccinated. Surveys have suggested that only 73% of the world population is willing to be vaccinated. The proportion varies considerably across countries and is lowest in France (54%) and highest in India (87%). Governments will likely launch information campaigns to convince people to be vaccinated. Dependent on the success of such campaigns, herd immunity may be delayed in some regions.
Nonetheless, financial markets are forward-looking and discount long-term cash flows in the pricing of bonds and stocks quickly in response to news. As long as the candidate vaccines live up to their trial results, markets will focus on economic re-opening efforts, stronger profits and cash flows for stocks.
We expect reflation will be the dominant theme over the next year. The general environment will likely be bullish for risky assets like shares and slightly bearish for bonds. As the pandemic eases, inflation should rise but the magnitude of the rise may be modest given the low level of capacity utilisation in the global economy. Central banks’ continuing dovish policies will support asset prices and lead to a further chase for yield. Corporate bonds will likely outperform sovereign bonds in this environment. Within shares, value should outperform growth – driven by the recovery in the cyclical sectors. However, we caution against the expectation that value stocks will recover all their relative underperformance versus growth stocks, given some of the structural advantages of growth investments. Finally, we expect active managers to outperform as different sectors and regions will recover at different speeds and as markets will be less dominated by Coronavirus headlines.
Looking ahead, it’s helpful to remember that markets rarely move linearly and that there will likely be market fluctuations in this reflationary phase. The most significant short-term risk is escalating Coronavirus cases in the Northern Hemisphere, which may lead to more lockdowns and, in a worst case scenario, technical ‘double-dip’ recessions for some countries in the December quarter. However, positive vaccine developments may mean financial markets will pay less attention to such developments. Investors should also be wary of being overly optimistic over share market returns. While they’ve significantly recovered most if not all their losses, the upside potential may be more limited.
In the meantime, Colonial First State will continue closely monitoring market developments and communicating closely with our skilled investment managers about the risks and opportunities in markets. Learn more about investments and get the latest updates on our website.