Once every four years, investor attention is riveted on the outcome of the US presidential election. In 2016, Donald Trump's surprise victory was followed by a surge in US equities and a sharp spike in long-term rates. This year, investors had to revise their political expectations. Joe Biden won the White House, but there was no Democratic ‘blue wave’ with sweeping control of both the House of Representatives and the Senate.
The final composition of the Senate won’t be known until after the run-off races for two seats in Georgia on 5 January. If the Democrats win both seats, they would tie with the Republicans in the Senate. Vice-president Kamala Harris would then cast the deciding vote, potentially permitting the Democrats to enact much more of their plans than would be the case under a Republican Senate majority.
Meanwhile, the outgoing president has bluntly refused to accept his defeat. Even so, and despite a host of legal challenges from the Republican side, the transition has begun.
The main source of investor optimism: News on COVID vaccines
The announcements throughout November on promising results of clinical trials helped drive equity indices to all-time highs (in the US) or return to highs not seen for decades (Japan). Investors appeared convinced that an efficient and safe vaccine will soon be readily available.
Seemingly beyond hope just a few months ago, this prospect helped markets to avoid succumbing to news of the pandemic’s resurgence and its damping impact on economic activity. The new lockdown measures put in place in late October in Europe led to a sharp deterioration in the services sector, which is likely to mean a contraction in GDP in Q4. In the US, a spike in virus cases in early December after the Thanksgiving holiday could lead to new restrictions or greater consumer caution, which would weigh on US growth in early 2021.
Faced with this bleak short-term outlook, investors chose to focus on the possibility of a cyclical recovery enabled by mass vaccination. They also remained convinced that economic policies would continue to support activity, encouraged by central bankers hinting at further monetary easing in December or early in 2021.
Toward the end of the month, investors’ attention turned to Joe Biden's cabinet appointments. Financial markets welcomed the naming of former Federal Reserve chair Janet Yellen as Treasury Secretary.
Broad-based equity rally
Indices and sectors that had lagged so far this year perked up in November. European equities rose by 18.1% (EuroSTOXX 50), but are still down by 6.7% over the year to date. In the US, the Dow Jones index (+11.8%) surpassed for the first time ever the 30 000 threshold. The S&P 500 gained 10.8% over the month (and 12.1% year-to-date). In Japan, the Nikkei 225 index gained 15% (+11.7% in 11 months).
Emerging Asia underperformed other emerging markets in November, but is still up by 17.9% year-to-date versus 8.1% for the MSCI Emerging index in US dollar terms, which returned 9.2% in November.
At the global level, energy (driven by the recovery in oil prices), financial stocks and cyclical sectors markedly outperformed. Defensive sectors (utilities, consumer staples and telecommunications) underperformed.
ECB - Keeping a close watch
Early in November, German long-term yields rose along with their US counterparts: The 10-year Bund yield (-0.63% at the end of October) returned to above -0.50%, its highest since mid-September. It then slipped back, as did US rates. Weaker economic indicators played a role. They suggest a fourth quarter GDP contraction as European economies face lockdowns to curb COVID infections.
Equities rose sharply after the first report of promising vaccine test results, as did long-term yields, seemingly causing the ECB to reassess the actions needed to keep financial conditions favourable. This could be seen in the changes in PEPP asset purchases. From an average of EUR 14 billion a week since early October, purchases spiked higher to EUR 20 billion for the week to 13 November and remained close to that level thereafter as the central bank sought to contain the upward pressure on rates.
‘Peripheral’ eurozone bond markets benefited from this increase in purchases and investors' search for yield. The Italian 10-year rate eased by 13bp to 0.63% at the end of November, the Spanish 10-year rate eased by 6bp to 0.08% and the Portuguese 10-year rate slid back below 0%, finishing at 0.03% (-7bp).
Given the ECB’s accommodative policy, which may be loosened further in December, even the shilly-shallying over the Next Generation EU stimulus plan failed to weigh on ‘peripheral’ markets.
Year-end volatility; positive medium-term outlook
The recent announcements on the vaccines are undoubtedly good news, not only in terms of easing the health crisis, but also for financial markets since they increase the likelihood of a cyclical recovery in 2021.
The coming weeks are likely to see both disappointments and new hopes depending on the progress made on the shots. Despite all that, a surge of hopeful excitement has led drug authorisation agencies to fast-track approval procedures, and governments in major developed countries to announce vaccination campaigns as early as Q1 2021, even as large-scale testing continues.
In short, the equity rally appears justified and the medium-term outlook for risky assets has improved. An efficient, soon-to-be-available vaccine should give rise to a rotation to sectors or markets that have lagged since April. Such a rotation would not be mechanical, but take into account the fundamentals of each industry and company.
In the very short term, investors still need to remain flexible in their asset allocations. The resurgence of the pandemic poses risks to economic activity as we approach the end of this year. Current equity valuations, particularly in the US, do not seem to us to accurately reflect all these risks as investors have repositioned themselves in recent weeks after being more hesitant during much of the rally.
Nevertheless, central banks remain dovish and could become even more so in December. In addition, bold fiscal stimuli look set continue to support activity in 2021.
All these factors remain supportive of equities over the medium term, especially cyclical sectors.
Any views expressed here are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may take different investment decisions for different clients. The views expressed in this podcast do not in any way constitute investment advice.
The value of investments and the income they generate may go down as well as up and it is possible that investors will not recover their initial outlay. Past performance is no guarantee for future returns.
Investing in emerging markets, or specialised or restricted sectors is likely to be subject to a higher-than-average volatility due to a high degree of concentration, greater uncertainty because less information is available, there is less liquidity or due to greater sensitivity to changes in market conditions (social, political and economic conditions).
Some emerging markets offer less security than the majority of international developed markets. For this reason, services for portfolio transactions, liquidation and conservation on behalf of funds invested in emerging markets may carry greater risk.