What to expect in the next stage of the Covid Vaccine rally

There is, finally, a light at the end of the very long tunnel that has been Coved -19. Monday’s wonderful news that the tie up between Pfizer and BioNTec had yielded a vaccine that was 90% effective in late stage trials has hit financial markets like a tsunami. Stock markets globally have surged, previously unloved stocks have recovered as  the prospect of life returning to normal is rapidly priced into stock markets. Bond yields have risen as the prospect of further central bank stimulus starts to fade. The vaccine news has sustained markets for two days, however, there are signs that market exuberance is fading and a pullback is on its way. However, this doesn’t mean that the recovery trend is over. 

Tech powers its way back to the top of the leader board

Late in the US session on Wednesday tech stocks started to rise again, they fell sharply on Monday as the market rotated out of growth stocks and towards value stocks in the hope of a profound recovery in their fortunes. Hence airlines, hotel groups and retailers all outperformed the tech sector at the start of the week. The reversal on Wednesday meant that Zoom and Amazon were up a whopping 9% and 3% respectively, while Macy’s, the department store, was down 0.5%. The reversal of fortune for Zoom and Amazon is a reflection of what life after Coved will look like. While some things will go back to normal, the digitalised nature of lockdown is here to stay. People are still likely to work from home and use video conferencing technology, and now that ever greater numbers of people have experienced the benefits of ordering goods and getting them delivered to their door 24 hours later, it’s easy to see that online shopping is here to stay, and will only get bigger in the coming years. 

What next for banks and airlines 

The value stocks that had done so well took a back seat to the tech giants on Wednesday. JP Morgan fell 1.5%, while Delta Airlines was down 5%, after rising by an impressive $8 per share since Monday. While we believe that airline travel will return to some normality over the coming months, as long as there is no delay to the vaccine getting rolled out, the pandemic has caused structural changes to the airline industry. For example, business travel may not recover to the same volumes pre the pandemic as video conferencing is a cheaper, and effective substitute. This could dent airline profit margins since business class travel is a high margin service, and without it profits could get hit, even if leisure travel returns to normal levels in the coming months and years. 

Expect a short term pullback in European shares 

European markets could play catch up on Thursday. On Wednesday, the FTSE 100 was up 1.5%, outpacing gains for European shares. The top performer in the UK index was IAG, the parent company of British Airways, which rose 8%. Its stock price has jumped more than 40% on the vaccine news, so if Europe follows the US markets then IAG could come under pressure as we move towards the end of the week. This does not mean that we would write off IAG completely. The news of a vaccine is undoubtedly good news for the airline sector, and this may be the start of a prolonged recovery trade. However, after such large gains in the last two days we think that a pullback is to be expected, however we would expect traders to use any decline in the share price of IAG and others including Delta in the US, to enter into long positions at more attractive levels than we have seen after this week’s rally. 

Why the euro may continue to suffer 

The same reasoning is behind our view on banks. We expect the decline in bank stocks to be short as the bull case for global banks is strong. If Covid can be eradicated, or at least kept at bay with the Pfizer BioNTec and other vaccines that will become available, then central banks will not need to use the more extreme tools of monetary policy such as negative interest rates or expand further their bond purchase programmes. Retail banks such as JP Morgan and Lloyds in the UK are likely to benefit from the increase in interest rates and the steepening of yield curves that has occurred as a result of the Covid vaccine news. In the US, 10-year treasury yields rose to 0.97% on Wednesday, the highest level since March. In the UK, the 10-year yield has risen to 0.4%, which is also a multi-month high. The bond market rarely makes large movements; thus, we believe that this is the beginning of an upward trend for developed world bond yields (prices are likely to fall), which is good news for retail banking stocks, and the dollar. The euro may not fare as well as GBP and USD, as European bond yields have not moved higher to the same extent as those in the UK and the US this week. The euro could lag its developed market peers in the coming days as the market prices in an uneven economic recovery for euro member states; added to this a vaccination programme for the currency bloc is a tougher logistical challenge than it is for the UK or the US, which will have centralised forces rolling out a vaccine. These two factors could weigh on the euro for the medium term. 

Why GBP could shrug off any disappointing economic news 

While the focus is understandably on the vaccine news, even Joe Biden’s US Presidential election victory is playing second fiddle. It is worth remembering that many countries in Europe are still fighting the coronavirus and are in various stages of lockdown. Added to this, we are still trying to figure out the cost of the pandemic. It is unclear if the economic data will matter too much this week. UK Q3 GDP is released on Thursday. The market is expecting a decent 15.8% boost to growth, mostly fuelled by private consumption and public spending. If the number surprises to the upside, then this could have a positive impact on GBP, which is managing to stay above $1.32 vs. the USD. EUR/GBP could also come under pressure. The euro has been falling vs. the pound since September. The break below 0.90 was a psychological blow to the euro bulls, the next support level is 0.8880 and then 0.8690, the low from May. Even if Thursday’s UK GDP report disappoints, which we view as a low probability event, we doubt this will hurt sterling as we think that the market will shrug off any economic disappointments this week. Afterall, now that there is an effective vaccine, we doubt that lockdown will be extended beyond December 3rd, and the bounce back in UK economic growth could be considerable.