With a likely split-Congress outcome lowering the chances of substantial policy shifts, investors are refocusing on supportive fundamentals and the recovering economy. Raymond James CIO Larry Adam offers his perspective.
Coming off its best week since April (7.3%), the S&P 500 rallied about 1.2% on Monday and narrowly missed setting a new record high as Joe Biden was officially declared president-elect over the weekend and Pfizer announced a vaccine efficacy rate above 90% in its Phase III trials.
Although the two key run-off Senate elections in Georgia won’t occur until January, the outcome of the 2020 election appears to be split government, and with substantial policy shifts seeming unlikely, investors have been able to refocus on the overall supportive fundamentals.
As for Pfizer’s announcement, a vaccine seems to be developing at warp speed given that we only received positive Phase I study results about six months ago. With Pfizer’s efficacy rate well above the necessary 50-60% threshold, it’s hard not to join the markets in celebrating this scientific feat (the previous quickest vaccine development on record was four years). While there are still many questions surrounding the durability and production goals of this vaccine, this is a monumental step toward the eventual return to normality.
Markets see split government as a positive
Ahead of Election Day, most investors assumed that delayed results in the presidential and congressional elections would induce volatility and cause the markets to falter. While the final results were unknown, it was apparent that split government was the most likely outcome, and instead the S&P 500 had its best election week performance since 1932.
Leading this rally was the decreased probability of a tax increase, which we expected would reduce 2021 S&P 500 earnings by about 10%. With policy risk subdued, investors were able to focus more squarely on the fundamentals, which we believe are supportive of equities in the longer term.
Recent economic data provides evidence that the U.S. economy is still on the road to recovery. Last week, both ISM indices remained in expansion territory, the unemployment rate fell from 7.9% to 6.9%, and 638,000 jobs were added in the month of October (surpassing consensus estimates by 58,000). Additionally, a better-than-expected third quarter earnings season will hopefully carry into 2021. Since the end of the third quarter, the earnings estimate has been revised higher by 17%, the best upward quarterly revision since 2002.
While the equity market may experience some short-term volatility ahead of the run-off elections in Georgia, our base case is the Republicans win at least one seat and maintain control of the Senate. However, in the event the Democratic candidates sweep the two seats, our expectation is that the most aggressive policy shifts will remain limited. More important, a supportive macroeconomic backdrop and the ongoing improvement in earnings will likely carry more weight over the longer term in determining the trajectory of the equity market.
Efficacy is just one piece of the puzzle
On Monday, Pfizer announced that it achieved an efficacy rate north of 90% at just seven days following the second dosage of their MRNA-based vaccine candidate. The company hopes to apply for emergency use authorization after it collects two full months of data, which correlates to the third week of November. With more than 50 million COVID-19 cases globally and over 10 million cases in the U.S. alone, Pfizer’s announcement gives hope that there is a way to mitigate the COVID-19 crisis. This is especially true given that other MRNA-based vaccines (e.g., Moderna) are now likely to be successful too.
While this is a positive and significant development, a few more dynamics need to be considered. First, scientists have yet to disclose how long the heightened level of immunity may last and how potential mutations in the virus may impact its protection. Second, while Pfizer has previously stated it would have 50 million doses available in 2020 and 1.3 billion doses in 2021, it currently only has hundreds of thousands available.
Given that this vaccine requires super-cooled containers, the production timeline and speed of transport are yet to be determined. Raymond James Biotechnology Analyst Steve Seedhouse, Ph.D., still believes that initial dosages will likely be available for first responders and at-risk groups come the end of this year but that widespread availability will not occur until 2021. And lastly, even if all production goals are met, the general public must be willing to receive the vaccination. Over the last several months, several studies suggested that public trust surrounding the safety of a COVID-19 vaccine had declined, mostly due to the record speeds at which pharmaceutical companies were conducting trials. While a vaccine may have been developed in record time, it may take time or additional evidence of safety for the majority of the population to feel comfortable receiving it.
The likely outcome of a split government has removed some of the political risk from the financial markets, but we expect near-term volatility surrounding vaccine development and the COVID-19 outbreak to remain. While the vaccine development is a positive signal, it cannot remedy the current surge or the risk of the outbreak worsening as we head into the winter months.
Hear more from the leading professionals at Raymond James: Biden’s Victory & Vaccine Surprise
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