How the Vaccine Era Could Be a Sweet Spot for Stocks --

 DJ How the Vaccine Era Could Be a Sweet Spot for Stocks -- 

By Jacob Sonenshine

Vaccines for Covid-19 -- and the economic recovery they are expected to bring -- may not stoke much inflation. That could be beneficial for stocks. 

Counting only Moderna's (ticker: MRNA) vaccine and the one jointly produced by Pfizer (PFE) and BioNTech (BNTX), more than 2 billion doses could be distributed by the end of 2021, making possible real progress in the fight against the pandemic. That could allow states -- and other countries -- to roll back economically damaging measures they have imposed to keep people safe. 

At the same time, there may be pent-up demand. Consumers are sitting on roughly $15 trillion of cash, according to Morgan Stanley economists, and in recent months, they have saved about 17% of their income, up from 7% before the pandemic. 

The bottom line is that when it is safe to go outside and when businesses resume hiring, consumer spending could explode. 

Markets have priced this in. Since the close of trading on Nov. 6, the last day of market activity before the recent flurry of positive vaccine news, value stocks, which are more correlated to changes in the economy than shares of growth companies, have gotten a jolt. The Vanguard S&P 500 Value ETF (VOOV) is up 5.4%. The 10-year Treasury yield is up to 0.84% from 0.81%. 

A surge in hiring and spending would ordinarily tend to push prices higher, but investors don't seem to expect a spike in inflation. "Lack of higher inflation expectations follows despite [fact that] the vaccine news has spurred hope of economies returning to normal earlier than anticipated," wrote economists at Citigroup in a note. 

Market indicators point in the same direction. Price levels in the five-year inflation swaps market -- a popular gauge of expectations for inflation -- are indicating an annual rate of just below 2%. Although the 10-year Treasury yield hit 0.96% on Nov. 10, indicating investors were demanding higher returns to compensate them as inflation reduces the value of the fixed payouts bonds offer, it has since tumbled. 

Expectations for inflation are indeed higher than during the market's pandemic-related panic in late March. Then, five-year inflation swaps were indicating inflation of 1.4%, while the 10-year Treasury yield was at 0.56%. But inflation expectations have climbed only to pre-pandemic levels, not past them. 

Also, while prices dropped in March through May this year, they didn't drop as drastically as gross domestic product -- total economic output -- ultimately fell. Consumer prices increased 1.5% year over year in March, 0.3% in April and 0.1% in May, and then began rebounding a bit year to date. 

Price levels weren't badly depressed in 2020, so the year-over-year percentage increases in 2021 won't be terribly dramatic, especially for the winter, summer, and fall. As the Citi economists put it, "base effects will support headline inflation arithmetically in spring 2021, but stronger underlying inflation requires a sustained improvement." 

Roughly 40% of the Personal Consumption Expenditure index, one of the Federal Reserve's preferred inflation metrics, comes from the cost of health care and rent, estimates Brett Ryan, senior economist at Deutsche Bank. Those prices levels are not expected to soar, Ryan said. 

So where does this leave markets? 

The Federal Reserve's policy is to have inflation average 2% over an unspecified period. The implication is that so as long as inflation remains as low as expected -- far below the 2% threshold -- the Fed will continue its effort to bolster growth and prices. 

In practical terms, that would mean the Fed would keep short-term rates pinned near 0%, and continue buying long-dated Treasury debt at the current pace. Those purchases keep prices of the bonds high, and yields low, encouraging investors to buy riskier corporate debt. Yields on that debt remains lower than it would be otherwise, and companies are able to borrow. 

The Fed is buying $80 billion of Treasuries per week. "Where inflation is now doesn't give the Fed any reason to change what it's done," said Lindsey Bell, chief market strategist at Ally Invest. 

With Treasury yields expected to remain low -- though many on Wall Street, like Citi's strategists, do expect the 10-year yield to reach above 1% in 2021 -- investors will continue to have interest in the better returns stocks can offer. Bell said this is "supportive" of stocks, but that because rates are unlikely to fall below zero, as they have in Europe, the Fed isn't likely to be a source of additional gains. 

The point is that the S&P 500 and the stock market as a whole may be approaching a sweet spot where vaccines spur economic activity but not inflation. That could keep the Fed's foot on the gas. 

Write to Jacob Sonenshine at 

(END) Dow Jones Newswires 

November 21, 2020 07:29 ET (12:29 GMT) 

Copyright (c) 2020 Dow Jones & Company, Inc.


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