COVID Vaccine: Potential Implications for U.S. Equities and Fixed income | Lord Abbett
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Economic Insights

The positive market response unleashed by the preliminary success of Pfizer’s compound could have a long way to go.

Pfizer’s announcement on November 9 that its COVID-19 vaccine is registering 90% efficacy in an intermediate readout from its Phase Three clinical trial was better than even the most starry-eyed optimists could have envisioned. In our view, the Pfizer compound, in conjunction with a parallel vaccine from Moderna, offers the potential for a return to more or less normal life, following widespread distribution in the second half of 2021. This is the best stimulus investors could have hoped for, and it had a very large positive impact on risk assets on November 9. But we believe the market shifts that were unleashed following the announcement could have a long way to go.

Why? As we have noted before, cash holdings are very high, and investor positioning has been broadly “risk off” since the 2020 first quarter. With the election settled and a high-end vaccine solution seemingly at hand, this positioning appears to be too heavily skewed towards safety.

 

Figure 1. Safety-Conscious Investors Have Piled into Cash

Market value of U.S. zero-maturity money supply versus Bloomberg Barclays U.S. Aggregate Bond Index, August 23, 2001­–October 29, 2020

Source: Bloomberg. Data as of October 29, 2020 (most recent month-end). The zero-maturity money supply, also known as money of zero maturity  (MZM) is a measure of the liquid money supply within the U.S. economy. MZM represents all money in M2 (a component of the money supply) less the time deposits, plus all money market funds. For money to be included in MZM, it has to be redeemable at par value, which is why money in time related deposits are not included in MZM.

Past performance is not a reliable indicator or guarantee of future results. For illustrative purposes only and does not represent any specific portfolio managed by Lord Abbett or any particular investment. Indexes are unmanaged, do not reflect the deduction of fees or expenses, and are not available for direct investment.

 

Even before the events of the past week, data reports indicated that the economy was recovering more consistently, and corporate earnings were coming in at a record pace of positive surprises for the second straight quarter. But these positive trends were tenuous as vaccine, fiscal stimulus, and election risks posed a daunting hurdle. The bar has now dropped, as the first vaccine news delivered at the very high end of expectations, and the election has apparently resulted in divided government—the configuration that markets have responded to most positively in the past.

Investment Implications

What does this suggest for key asset classes? For U.S. equities, we think that while Innovation and Growth remain attractive from a secular perspective, the extreme underperformance of Value and its sensitivity to a more secure cyclical recovery suggest a prolonged rebalancing could now ensue. The same applies to small cap stocks, in our opinion, as balance sheet risk starts to fade, and investors get more comfortable with lower-quality companies.

 

Figure 2. Lagging U.S. Value Equities May Be Primed for a Reversal

Price differential of iShares Russell 1000 Value ETF versus Russell 1000 Growth ETF, January 1, 2018–November 9, 2020

Source: Bloomberg. Data as of November 9, 2020. The chart depicts the price differential of the iShares Russell 1000 Value ETF (IWD) and the iShares Russell 1000 Growth ETF (IWF), which mirror the respective Russell 1000 subindexes.

Past performance is not a reliable indicator or guarantee of future results. For illustrative purposes only and does not represent any specific portfolio managed by Lord Abbett or any particular investment. Indexes are unmanaged, do not reflect the deduction of fees or expenses, and are not available for direct investment.

 

On the U.S. fixed-income side, while option-adjusted spreads on high yield have tightened considerably, we think they may have room to narrow further in a U.S. economic recovery, especially due to the high-yield market’s higher average credit quality and investors’ ongoing search for yield. This applies to credit more broadly, especially the portions of the market that have trailed the overall rally until now (commercial mortgage-backed securities, or CMBS, and CCC-rated bonds figure prominently among the laggards).

 

Figure 3. U.S. High Yield Spreads Have Narrowed Sharply Since March 2020

Option-adjusted spread on the Bloomberg Barclays U.S. Corporate High Yield Index, June 4, 2015–November 9, 2020

Source: Bloomberg. Data as of November 9, 2020.
Past performance is not a reliable indicator or guarantee of future results. For illustrative purposes only and does not represent any specific portfolio managed by Lord Abbett or any particular investment. Indexes are unmanaged, do not reflect the deduction of fees or expenses, and are not available for direct investment.

 

Lastly, while inflation fears will likely tick up in the short run, just as they did when the last economic recovery started to gather strength, high unemployment and a large debt burden should constrain those worries and eventually cap any rise in yields, limiting the threat to asset prices from a rising discount rate.

A Final Word

While the early results for the Pfizer vaccine are welcome news, many challenges remain in terms of approvals, distribution, and the ultimate efficacy of any large-scale inoculation. Still, the market action on November 9 may indicate a turning point in investors’ willingness to more broadly embrace risk in the COVID era.

 

The value of investments in fixed-income securities will change as interest rates fluctuate and in response to market movements. Generally, when interest rates rise, the prices of debt securities fall, and when interest rates fall, prices generally rise. U.S. Treasuries are debt obligations issued and backed by the full faith and credit of the U.S. government. Income from Treasury securities is exempt from state and local taxes. Although Treasuries are considered to have low credit risk, they are affected by other types of risk—mainly interest rate risk (when interest rates rise, the market value of debt obligations tends to drop) and inflation risk. The value of investments in equity securities will fluctuate in response to general economic conditions and to changes in the prospects of particular companies and/or sectors in the economy.

Forecasts and projections are based on current market conditions and are subject to change without notice. Projections should not be considered a guarantee.

This article may contain assumptions that are “forward-looking statements,” which are based on certain assumptions of future events. Actual events are difficult to predict and may differ from those assumed. There can be no assurance that forward-looking statements will materialize or that actual returns or results will not be materially different from those described here.

Money of Zero Maturity (MZM) is a measure of the liquid money supply within an economy. MZM represents all money in M2 (a component of the money supply) less the time deposits, plus all money market funds. For money to be included in MZM, it has to be redeemable at par value, which is why money in time related deposits are not included in MZM.

The option-adjusted spread (OAS) is the measurement of the spread of a fixed-income security rate and the risk-free rate of return, which is adjusted to take into account an embedded option. Typically, an analyst uses the Treasury securities yield for the risk-free rate.

The Bloomberg Barclays U.S. Aggregate Bond Index represents securities that are SEC-registered, taxable, and dollar denominated. The index covers the U.S. investment grade fixed rate bond market, with index components for government and corporate securities, mortgage pass-through securities, and asset-backed securities. Total return comprises price appreciation/depreciation and income as a percentage of the original investment.

The Bloomberg Barclays U.S. Corporate High Yield Bond Index is a market value-weighted index which covers the U.S. non-investment grade fixed-rate debt market. The index is composed of U.S. dollar-denominated corporate debt in Industrial, Utility, and Finance sectors with a minimum $150 million par amount outstanding and a maturity greater than 1 year. The index includes reinvestment of income.

Bloomberg Barclays Index Information:

Source: Bloomberg Index Services Limited. BLOOMBERG® is a trademark and service mark of Bloomberg Finance L.P. and its affiliates (collectively “Bloomberg”). BARCLAYS® is a trademark and service mark of Barclays Bank Plc (collectively with its affiliates, “Barclays”), used under license. Bloomberg or Bloomberg’s licensors, including Barclays, own all proprietary rights in the Bloomberg Barclays Indices. Neither Bloomberg nor Barclays approves or endorses this material or guarantees the accuracy or completeness of any information herein, or makes any warranty, express or implied, as to the results to be obtained therefrom and, to the maximum extent allowed by law, neither shall have any liability or responsibility for injury or damages arising in connection therewith.

The Russell 1000® Growth Index measures the performance of those Russell 1000 companies with higher price-to-book ratios and higher forecasted growth values.

The Russell 1000® Value Index measures the performance of those Russell 1000 companies with lower price-to-book ratios and lower forecasted growth values.

Indexes are unmanaged, do not reflect the deduction or expenses, and are not available for direct investment.

The information provided herein is not directed at any investor or category of investors and is provided solely as general information about our products and services and to otherwise provide general investment education.  No information contained herein should be regarded as a suggestion to engage in or refrain from any investment-related course of action as Lord, Abbett & Co LLC (and its affiliates, “Lord Abbett”) is not undertaking to provide impartial investment advice, act as an impartial adviser, or give advice in a fiduciary capacity with respect to the materials presented herein.   If you are an individual retirement investor, contact your financial advisor or other non-Lord Abbett fiduciary about whether any given investment idea, strategy, product, or service described herein may be appropriate for your circumstances.

The opinions in the preceding commentary are as of the date of publication and are subject to change. Additionally, the opinions may not represent the opinions of the firm as a whole. The document is not intended for use as forecast, research or investment advice concerning any particular investment or the markets in general, and it is not intended to be legal advice or tax advice. This document is prepared based on information Lord Abbett deems reliable; however, Lord Abbett does not warrant the accuracy and completeness of the information.

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