Aviation and hospitality are among the cyclical stocks enjoying a second wind after US company Moderna delivered markets a second dose of positive vaccine news.
The Moderna vaccine has almost 95% efficacy and unlike the Pfizer/BioNTech vaccine, which sent markets up last week with its interim phase III trial results, does not need to be stored at logistically challenging temperatures.
Hargreaves Lansdown senior investment and markets analyst Susannah Streeter said the Moderna announcement “adds to the confidence washing through the financial markets” noting the dramatic effect it’s had on companies worst-hit by the pandemic.
Rolls Royce, which jumped 40% on last week’s news, again led the FTSE 100 gains on Monday rising 9.9%, while British Airways owner IAG gained 9.8%, as did Premier Inn-owner Whitbread.
Principal Global Investors chief strategist Seema Shah (pictured) says the announcement should solidify the market rally that has been in play since last week. “Visibility towards a return to normality is increasing, and this should provide more fuel to the reflation rally, with small caps, value and cyclicals clear beneficiaries,” Shah says.
What are the implications for the vaccine from Pfizer and BioNTech?
Axa Framlington Biotech fund manager Linden Thomson anticipates more vaccine data for other technologies before the year’s end and into 2021, but she notes the Moderna vaccine has elements that already look more appealing than the Pfizer/BioNTech vaccine.
“The Moderna vaccine looks to be able to be distributed with normal vaccine storage and infrastructure, allowing it to be refrigerated for 30 days. This makes it logistically easier to store and distribute across the world than BioNTech’s as it stands at the moment.”
BioNTech’s stock fell 16% on the news of the Moderna vaccine, while Pfizer was down 3.8%.
Thomson warns that mass distribution is likely to stretch into the second half of 2021, meaning new drugs that can treat Covid-19, rather than immunising against it, are still likely to play a role in navigating the pandemic.
What do the coronavirus vaccines mean for central banks and bonds?
The prospect of a vaccine raises a number of important questions. The most important is that of inflation and therefore the likely direction of interest rates. There is considerable stimulus still in the system and no immediate sign of the central banks turning off the taps. At the margin, higher inflation would appear to be a risk and ultimately, a rate rise seems a little closer.
This would certainly be bad for bonds.
Rupert Thompson, chief investment officer at Kingswood, says: “Return prospects look particularly dire for conventional government bonds[…]. Even though central banks have all but confirmed there will be no rise in rates for the foreseeable future, bond yields still look set to edge higher as inflation pressures slowly build.
“This in turn will lead to capital losses and could produce negative returns overall.”
The impact is already being felt in the European bond market.
The German 10-year bond yield has moved from –0.64% on 4 November to 0.48% on 11 November, while the French 10-year bond yield has seen a similar movement, from 0.36% to 0.24%.
These shifts should be viewed in the context of historically low levels, however. In many cases, they only take bond yields back to their level in October before the latest round of lockdowns were announced.
Implications of a higher risk free rate for US tech giants
This potential shift in inflation and interest rates is also being felt in equity markets. A higher risk free rate would mean that future cash flows have less value.
The market has supported relatively high valuations in some sectors because a low risk free rate has flattered their future cash flows. If inflation rears its head, the highest valued stocks could start to look vulnerable.
The most obvious targets are the US technology stocks, where valuations are extremely high.
However, Europe has its own high growth stocks that could weaken – notably in the consumer area.
Mark Philips, a European equity analyst from Ned Davis Research, says there is already a rotation to more cyclical stocks: “Economically sensitive sectors have been performing well, even before the news of a vaccine breakthrough, which bodes well for the broader European market.
“In the past, cyclical sectors have tended to underperform the broader market during significant drawdowns.
“The recent market decline stands out as unusual in terms of the relative strength of three economically sensitive sectors. The announcement of a vaccine candidate served to confirm these trends further. The economically sensitive consumer, industrials and materials sectors outperformed the broader market over the three months up until 6 November.
“Most notably, the consumer discretionary sector reached a new all-time relative high on the same day. Such trends point to a cyclical economic recovery.”
Covid has permanently changed some consumer habits
However, Dhaval Joshi, chief strategist at BCA Research, sounds a note of caution: “The world is unlikely to go back to business as usual. We won’t go back to full time office work, so won’t need as much office space. Cafes that serve the office market in big cities may not longer be viable.
“We have permanently changed our attitude to online retail and to business travel.”
This means there is likely to be some level of persistent unemployment, which will act as a brake on economic growth. Joshi also disputes the inflation thesis: “There is an automatic stabiliser in that if the pandemic gets better, governments around the world will withdraw stimulus […] this should prevent an inflationary environment.”
He believes investors need to be more nuanced in the way they approach buoyant markets.
It is not enough, he says, to say that everything that has gone down must go up: “There are certain sectors where the long-term viability is in question. Companies could be a terminal decline, so the correct value is zero. In others, there has been a major shock, but it is recoverable.
“Investors need to distinguish between those companies that have sold off in a justified way and those that can recover.”
Airlines are a good example: while regional airlines serving the holiday market may survive, but it could be more difficult for those who rely on business travel.
The vaccine is good news for economic recovery and for some companies may have come in time to prevent permanent decline.
However, the pandemic has prompted structural changes that will see some businesses slip into permanent decline.
This, along with the withdrawal of stimulus, may prevent any surge in inflation and halt investor enthusiasm for some beaten-up areas.
