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Highlights Stocks jumped earlier this week on encouraging news on the vaccine front. While we remain positive on equities over a 12-month horizon, we would stress five vaccine-related risks that stock market investors should be cognizant of. First, immunizing most of the world’s population could prove logistically challenging, especially in light of widespread skepticism about the safety of the vaccine. Second, the virus could mutate in a way that undercuts the efficacy of the vaccine, as recent unsettling news from Denmark demonstrates. Third, vaccine optimism could, ironically, lead to weaker economic growth in the near term, even if it does lead to stronger growth in the medium and longer term. Fourth, improved prospects for a vaccine could reduce urgency around extending fiscal support. Fifth, bond yields could rise further in anticipation of an earlier return to full employment. This could pose a headwind for equities – especially growth stocks. V Is For Vaccine Stocks rallied this week on news that Pfizer’s trial of its Covid-19 vaccine had apparently immunized more than 90% of test participants. Such a high efficacy rate is on par with that of the childhood measles and smallpox vaccines, and well above the typical 30%-to-50% success rate for the seasonal flu (Chart 1). Chart 1Efficacy Rates Of Seasonal Flu Vaccines Are Not Exceptionally High Light At The End Of The Tunnel Light At The End Of The Tunnel Pfizer’s vaccine leverages messenger RNA (mRNA) technology developed by its German partner, BioNTech. The new technology is similar to the one being deployed by US-based Moderna. It uses synthetic genetic material to coax the body into producing antibodies, thus bypassing the time-consuming process of formulating a vaccine using dead or weakened forms of the actual pathogen. Pfizer began manufacturing the vaccine well before it knew it would work. It expects to ask the US Food and Drug Administration for emergency authorization to begin distribution by the end of November. If all goes well, the company will have 15-to-20 million doses available by the end of this year and enough to inoculate the entire US population by mid-2021. Ten other vaccines are in late-stage trials. It is widely expected that most of them will prove to be safe and effective (Chart 2). Chart 2When Will A Vaccine Become Available? Light At The End Of The Tunnel Light At The End Of The Tunnel Five Risks This week’s vaccine news is certainly encouraging, and it does pave the way for a rapid rebound in economic activity next year. Thus, we remain bullish on stocks over a 12-month horizon. Nevertheless, investors should be cognizant of five vaccine-related risks: Table 1Skepticism Over Vaccines Has Been Growing Over The Past Two Decades Light At The End Of The Tunnel Light At The End Of The Tunnel Risk #1: Immunizing most of the world’s population is likely to prove logistically challenging, especially in light of widespread public skepticism about the safety of the vaccine Pfizer’s version of the vaccine needs to be refrigerated at -70°C, making it difficult to store and transport. It will also need to be administered twice over the course of 21 days (Merck is the only company working on a single-dose vaccine). All this will require health care providers to keep track of who received which dose of the vaccine and at which time. There is also considerable uncertainty about how long immunity from the vaccine will last. Pfizer is cautiously optimistic that it will be over a year, but the truth is that no one really knows. Vaccinating most of the global population repeatedly year in, year out could prove to be challenging. In addition, the rollout of the vaccine could face widespread public skepticism. Even before the pandemic struck, confidence in the safety of vaccines was waning in the United States. A Gallup study published on January 14th of this year revealed that the share of Americans who thought it was important to get their children vaccinated fell from 94% in 2001 to 84% in 2019. The drop was particularly steep among Americans with children under the age of 18 (Table 1).1 Ten percent of Americans believed the thoroughly debunked claim that vaccines cause autism, while 46% were “unsure.”2  Things do not appear to have improved since then. According to a recent Pew Research Center survey conducted in September, only 51% of Americans said they would probably or definitely take the vaccine, down from 72% in May (Chart 3). The most common reason given for refusing to take it was “concern about side effects.” Chart 3Many Americans Are Wary Of A Covid-19 Vaccine Light At The End Of The Tunnel Light At The End Of The Tunnel The fact that all the Covid-19 vaccines under development do seem to produce worse side effects than the typical flu vaccine could amplify fears that “the cure is worse than the disease.” We could end up in a “You first; oh no you first; I insist you first” predicament where most people try to avoid being first in line to receive a vaccine. Still, it is important to keep in mind that not everyone has to be vaccinated for the virus to be eradicated. Suppose that 70% of the population needs to be inoculated to simulate herd immunity. If the vaccine works nine out of ten times, then 0.7/0.9 or 78% of the population would have to receive the vaccine. The true number could end up being less than that because some people who survived Covid will have antibodies for a while even if they remain unvaccinated. There is also tentative evidence that a few lucky souls may be naturally immune to the disease, perhaps by having contracted seasonal coronavirus colds in the past.3 Furthermore, both government and corporate policy are likely to push people to get vaccinated. For better or for worse, governments may require that children present vaccination certificates before being admitted to school. Airlines could also demand such certificates before one is allowed to travel. Insurance companies could cut off coverage for those who fail to get vaccinated. At any rate, it is difficult to see governments pursuing lockdown measures after a vaccine is widely available. The prevailing view will be that anyone who voluntarily chooses to remain unvaccinated cannot hold others hostage. Risk #2: The virus could mutate in a way that undercuts the efficacy of the vaccine Unlike most RNA-based viruses, coronaviruses carry an error-correction mechanism in their genomes. While this confers certain advantages to this family of viruses, it also means that they tend to mutate more slowly than notorious shape-shifters like the common flu. Nevertheless, there is plenty of evidence that SARS-CoV-2, the virus that causes Covid-19, has mutated since it first emerged in China.4 Viruses tend to become less lethal but more contagious over time. This is not surprising. A virus that kills its host will also kill itself. The speed at which a virus mutates is partly a function of how much of it is in circulation. The more copies of the virus there are, the larger the number of adaptive mutations there are likely to be. The fact that SARS-CoV-2 has spread to virtually every corner of the earth raises the risk that it will readily produce strains that the current batch of vaccines is not equipped to target. Unfortunately, this may not just be an idle threat. In Denmark, 12 people have already been infected with a novel strain of the virus that first emerged from mink farms. Although the data is still sketchy, the virus seemingly jumped from humans to minks early on in the pandemic, mutated within the mink population, and then jumped back to humans. The mutation appears to have altered the virus’s spike proteins. These are the proteins that the virus uses to gain entry into human cells. They are also the proteins that Pfizer’s vaccine is targeting. It is still not clear if the mutated strain will be vaccine-resistant, but governments are not taking any chances. The UK barred entry to travelers from Denmark on November 5th. Other countries may follow suit. Risk #3: Vaccine optimism could lead to weaker economic growth in the near term The release of the results of Pfizer’s vaccine trial comes at a time when the number of new confirmed global cases has reached record highs (Chart 4). The latest wave of the pandemic has hit Europe especially hard. European governments have responded by tightening lockdown measures (Chart 5). Euro area GDP is likely to contract in the fourth quarter. Chart 4The Number Of New Cases Continues To Rise Globally Light At The End Of The Tunnel Light At The End Of The Tunnel Chart 5Some Lockdown Measures Have Been Reintroduced Light At The End Of The Tunnel Light At The End Of The Tunnel While the development of a vaccine is good news for the economy in the medium-to-long term, it is not clear if it will help growth in the near term. On the one hand, vaccine optimism could cause firms to invest more, while curbing household precautionary savings. This would boost aggregate demand. On the other hand, vaccine optimism could prompt people to make even more effort to avoid getting sick. If you take shelter under a tree during an unforeseen rainstorm, you’re better off staying put until the storm passes... provided, of course, that the rainfall does not last too long. But what if you check your phone and see that the rain is supposed to fall uninterrupted for the next three days? That is a long time to spend under a tree. At that point, you are better off proceeding ahead. After all, you are going to get wet in any case. Chart 6Commercial Bankruptcy Filings Remain In Check Light At The End Of The Tunnel Light At The End Of The Tunnel The same logic applies to the pandemic. If you can avoid getting sick by hunkering down for a few more months until a vaccine becomes available, it is well worth doing so. However, if the prospects for a vaccine or effective treatment are poor, it makes less sense to hide from the rest of the world. Chances are you are going to get sick anyway. Risk #4: Improved prospects for a vaccine could reduce urgency around extending fiscal support So far, the pandemic has left only limited scarring on the global economy. For example, according to the American Bankruptcy Institute, corporate bankruptcies are lower now than they were this time last year (Chart 6). The same is true for delinquency rates on most consumer loans (Table 2).   Table 2A Snapshot Of Consumer Delinquencies Light At The End Of The Tunnel Light At The End Of The Tunnel Many economies have displayed resilience so far thanks to ample fiscal and monetary support. In Europe and Japan, the combination of wage subsidies and job retention programs has kept unemployment from rising significantly (Chart 7). The unemployment rate rose rapidly in the US, Canada, and Australia early on in the pandemic, but has since declined. In the US, there are now fewer than two unemployed workers per job opening (Chart 8). It took the US over five years to reach that point following the Global Financial Crisis. Chart 7Ample Fiscal Policy Has Helped Shield The Labor Market From The Pandemic Ample Fiscal Policy Has Helped Shield The Labor Market From The Pandemic Ample Fiscal Policy Has Helped Shield The Labor Market From The Pandemic Chart 8The Labor Market Is In A Better Place Now Compared To The Great Recession The Labor Market Is In A Better Place Now Compared To The Great Recession The Labor Market Is In A Better Place Now Compared To The Great Recession   The risk is that fiscal policy support will be withdrawn before lockdown measures can be lifted. While such a risk cannot be ignored, two things should help mitigate it. First, fiscal hawks are more likely to support a temporary stimulus package that lasts a few months rather than an open-ended support scheme that may be needed indefinitely. Second, public opinion still very much favors maintaining stimulus. According to a recent NY Times/Siena College poll, 72% of voters support a hypothetical $2 trillion stimulus package that extends emergency unemployment insurance benefits, distributes direct cash payments to households, and provides financial support to state and local governments (Table 3). Such a package is basically what the Democrats are proposing. Strikingly, when this package is described in non-partisan terms, even the majority of Republicans are in favor of it. Risk #5: Bond yields could rise further in anticipation of an earlier return to full employment If a premature tightening of fiscal policy is unlikely to sink the stock market, could higher bond yields do the trick? Central banks will not raise interest rates for the next few years. However, rate expectations could still rise further along the forward curve if investors believe that a vaccine will allow the output gap to close earlier than previously anticipated. Chart 9Policy Rate Expectations Remain Below Pre-Pandemic Levels Policy Rate Expectations Remain Below Pre-Pandemic Levels Policy Rate Expectations Remain Below Pre-Pandemic Levels Investors expect US short-term rates to average only 1.25% in 2027-28. While this is higher than prior to the vaccine announcement, it is still well below where rate expectations were at the start of the year. Long-dated rate expectations are similarly below pre-pandemic levels in most other economies (Chart 9). Upward revisions to where policy rates will be later this decade could lift long-term bond yields. Higher yields, in turn, could raise the discount rate that stock market investors use to calculate the present value of future cash flows. This might lead to lower equity prices. The valuation of growth companies, whose earnings may not be realized for many years to come, is especially vulnerable to changes in discount rates. Despite the threat posed from rising bond yields, we suspect that the actual impact on equity prices will be fairly modest. There are three reasons for this. First, any increase in bond yields will probably occur alongside rising inflation expectations. As such, real yields may not increase that much. Conceptually, it is real yields, rather than nominal yields, that matter for equity valuations. Second, provided that higher yields are reflective of stronger growth, earnings estimates are likely to drift up. Rising profits will dampen the impact of higher bond yields on equity valuations. Third, central banks have both the tools, and just as importantly, the inclination to keep bond yields from spiking as they did during the 2013 “taper tantrum.” These tools include QE, aggressive forward guidance, and if necessary, yield curve control strategies. Investment Conclusions The path to ending the pandemic is likely to be a bumpy one. Nevertheless, the balance between risk and reward still favors overweighting equities versus bonds over the next 12 months. Within the equity portion of a portfolio, investors should reallocate funds from US stocks to overseas markets and from growth stocks to value stocks. Growth stocks benefited from the pandemic and from falling bond yields, but will suffer as yields rise modestly from current levels and investors shift exposure to stocks that will benefit from the reopening of economies. Chart 10Stronger Global Growth Tends To Be A Headwind For The Dollar... While Dollar Weakness Usually Bodes Well For Non-US Stocks Stronger Global Growth Tends To Be A Headwind For The Dollar... While Dollar Weakness Usually Bodes Well For Non-US Stocks Stronger Global Growth Tends To Be A Headwind For The Dollar... While Dollar Weakness Usually Bodes Well For Non-US Stocks Chart 11EM Stocks Are Cheap Light At The End Of The Tunnel Light At The End Of The Tunnel As a countercyclical currency, the trade-weighted US dollar is likely to weaken further in 2021. Non-US stocks typically outperform their US peers when the dollar depreciates (Chart 10). A weaker dollar will provide an additional boost to emerging market equities, given that many EMs have a lot of dollar-denominated debt. Assuming Joe Biden becomes president, a de-escalation of the trade war would also help emerging markets, particularly China. Lastly, EM equities are still quite cheap based on cyclically-adjusted earnings (Chart 11). Peter Berezin Chief Global Strategist peterb@bcaresearch.com   Footnotes 1 Attitudes towards vaccines have shifted notably over the past two decades. The following survey captures the erosion of trust towards vaccines: RJ Reinhart, “Fewer in U.S. Continue to See Vaccines as Important,” Gallup, January 14, 2020. 2 One of the most widely known parental concerns about the safety of vaccines is linked to the hypothesis that the measles-mumps-rubella (MMR) vaccine causes autism. Since this hypothesis was published more than three decades ago, dozens of researchers have presented studies showing that the original claims are critically flawed. The evidence provided by the scientific community dismisses the link between vaccines and autism. Please see Jeffrey S. Gerber and Paul A. Offit, “Vaccines and Autism: A Tale of Shifting Hypotheses,” National Center for Biotechnology Information; and “Vaccines and Autism,” Children’s Hospital of Philadelphia, May 7, 2018. 3 There has been much debate over why some people are affected more than others by Covid-19. While much attention is given to personal characteristics (such as age, weight, or the presence of chronic illnesses), researchers have also investigated the possibility that prior exposure to coronaviruses have helped some to obtain a certain degree of natural immunity to Covid-19. Please see Yaqinuddin, Ahmed, “Cross-immunity between respiratory coronaviruses may limit COVID-19 fatalities,” Medical hypotheses, vol. 144 110049, (30 June, 2020). 4 One of the latent fears since the emergence of Covid-19 has been the possibility that it will mutate as it spreads. The following study suggests that different strains of the virus have been evolving on different continents, although it is not clear to what extend these mutations could affect treatment and immunization efforts. Please see Pachetti, M., Marini, B., Benedetti, F. et al., “Emerging SARS-CoV-2 mutation hot spots include a novel RNA-dependent-RNA polymerase variant,” Journal of Translational Medicine, 18:179 (2020). 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Highlights According to betting markets, Joe Biden is likely to become the 46th US president, with the Republicans maintaining control of the Senate. Such a balance of power could produce less fiscal stimulus than any of the other possible outcomes that were in play on Tuesday. Nevertheless, public opinion still favors a more expansionary fiscal policy. There is also an outside chance that Republicans in the Senate and Democrats in the House could craft a “grand bargain” that raises spending while making Trump’s corporate tax cuts permanent. The combination of continued easy monetary policy, modestly looser fiscal policy, and progress on a vaccine should be enough to keep global growth on an above-trend path next year. Bank shares have been the big losers since the election, but should start to outperform as yield curves re-steepen, worries about soaring bad loans subside, and lending growth outpaces bleak expectations. Investors should remain overweight global equities versus bonds. Be prepared to increase exposure to value stocks when clearer evidence emerges that the latest wave of the pandemic is cresting. Another Election Rollercoaster Last week, we highlighted that BCA’s geopolitical quant model was predicting a much closer election than most pundits were expecting. This indeed turned out to be the case. For a brief while on Tuesday night, betting markets were giving Donald Trump a greater than 75% chance of being re-elected. Unfortunately for the president, the good news did not last long. As more mail-in ballots and ballots cast in large urban areas were counted, the needle began to swing towards Joe Biden. At the time of writing, betting markets are giving Biden an 88% chance of becoming President. Trump still has a chance of winning, but assuming he loses Nevada, Michigan, and Wisconsin, he would need to win Pennsylvania, Arizona, and Georgia. That is a tall order. According to PredictIt, the latter three states are all leaning towards Biden (Chart 1). Chart 1The Distribution Of Electoral College Votes According To Betting Markets Election Fireworks Election Fireworks More positively for the GOP, the Republicans gained a net six seats in the House of Representatives, and held onto the Senate thanks to surprise victories for their candidates in Maine and North Carolina. That said, the Senate could still revert to Democratic hands depending on the final vote tally in Georgia, North Carolina, and Alaska; PredictIt assigns a 22% probability to the Democrats taking the Senate. Moreover, even if they fall short this time around, the Democrats still have a chance of winning a 50-seat de facto majority in the Senate if both Georgia races go to a run-off election on January 5. Stimulus In Peril? Assuming that Republicans maintain their majority in the Senate, tax hikes will remain off the table. This is good for stocks. Joe Biden would also lower the temperature on trade tensions with China. This, too, is good for stocks. Conversely, the odds of a major fiscal stimulus package have dropped. Donald Trump is not averse to big spending programs. In contrast, the Republicans in the Senate have rejected calls for a large stimulus bill. With Joe Biden as President, Republican senators would have even less incentive to give the Democrats what they want. Nevertheless, there are three reasons to think that Republicans will agree on a new stimulus bill. First, the economy needs it. While US growth should remain reasonably firm in the fourth quarter, this is only because households were able to build up some savings earlier this year which they can now draw on. As Chart 2 shows, since April, labor earnings have only grown one-third as much as personal spending. Transfer income has also plunged, resulting in a renewed drop in savings. Once households run out of accumulated savings, there is a risk that they will cut back on spending. Second, government borrowing rates remain extremely low by historic standards. Real rates are negative across the entire yield curve (Chart 3). Chart 2Savings Have Dropped Since April As Transfers Declined Election Fireworks Election Fireworks Chart 3Real Rates Are Negative Across The Entire Yield Curve Election Fireworks Election Fireworks   Third, and perhaps most politically salient, public opinion favors more expansionary fiscal policy. About 72% of voters support a hypothetical $2 trillion stimulus package that extends emergency unemployment insurance benefits, distributes direct cash payments to households, and provides financial support to state and local governments (Table 1). Such a package is basically what the Democrats are proposing. It is noteworthy that when this package is described in non-partisan terms, even the majority of Republicans are in favor of it. Table 1Strong Support For Stimulus Election Fireworks Election Fireworks All this suggests that Republicans will accede to a medium-sized stimulus bill in the neighbourhood of $700 billion-to-$1 trillion in order to avoid being perceived as stingy and obstructionist. Senate Majority Leader Mitch McConnell noted on Wednesday that getting a deal done was “job one.” While not our base case, a significantly larger bill is also possible. Most Republicans are not opposed to bigger budget deficits per se. It is increased social spending that they do not like. Budget deficits in the service of tax cuts are perfectly acceptable to the majority of Republicans. This raises the possibility that Republicans in the Senate and Democrats in the House could strike a grand bargain that raises spending while also promising additional tax relief. Most of Trump’s corporate tax cuts expire in 2025. A sizeable stimulus bill that makes these tax cuts permanent while increasing long-term spending on infrastructure, health care, education, and other Democratic priorities could still emerge from a divided Congress.   Wall Street Versus Main Street If one needed any more proof that what is good for Wall Street is not necessarily good for Main Street, the last three trading days provided it. The S&P 500 is up 6% since Monday’s close, spurred on by the reassurance that corporate taxes will not rise. In contrast, the 10-year bond yield has fallen 8 basis points on diminished prospects for a big stimulus package. The drop in bond yields since the election has raised the present value of corporate cash flows, leading to higher equity valuations. Growth companies have benefited disproportionately from falling bond yields. In contrast to value companies, investors expect growth companies to generate the bulk of their earnings far in the future. This makes their valuations highly sensitive to changes in discount rates. It is not surprising that tech shares – the FAANGs in particular – soared following the election (Chart 4). Chart 4Growth Equities Benefited Disproportionately From A Post-Election Drop In Yields Election Fireworks Election Fireworks A Bottom For The Big Banks? Bank shares tend to be overrepresented in value indices. Unlike tech, banks normally lose out when bond yields fall. As Chart 5 shows, net interest margins have collapsed for banks this year as bond yields have cratered. The drop in yields since the election has further punished bank shares. Chart 5Bank Net Interest Margins Have Collapsed As Bond Yields Have Cratered This Year Election Fireworks Election Fireworks Chart 6Commercial Bankruptcy Filings Remain In Check Election Fireworks Election Fireworks Yet, as our earlier discussion suggests, bond yields could rise again if the US Congress delivers more stimulus than currently expected. This would help banks, while potentially taking some of the wind from the sails of tech stocks. The combination of further fiscal easing and a vaccine next year could help banks in another way. If the global economy bounces back, banks would suffer fewer loan defaults. The biggest US banks have set aside more than $60 billion to cover potential loan losses. They have done so even though commercial bankruptcies have declined so far this year (Chart 6). A stronger economy would allow banks to release some of those provisions back into earnings.   Bank Regulation Is Not A Major Worry Anymore Wouldn’t the potential benefits to banks from more fiscal support and higher bond yields be outweighed by a greater regulatory burden under a Biden administration? Probably not. For one thing, a Republican Senate could block legislation that expanded regulation. Moreover, Biden hails from Delaware, a state that derives more than a quarter of its GDP from the finance and insurance sectors. He was only one of two Democrats on the Senate Judiciary Committee to vote in favor of the 2005 bankruptcy bill that made it more difficult for households to discharge their debts. It should also be stressed that most of the regulatory reforms that the Democrats sought after the financial crisis have already been encoded in the Dodd-Frank Act. The Act was passed during the Obama administration. While the Trump administration did water down some of its provisions, the changes were modest and had bipartisan support. Big Banks Are More Resilient Than Small Ones Today, US banks are better capitalized than they were in the years leading up to the financial crisis (Chart 7). The largest banks – the so-called Systemically Important Financial Institutions (SIFIs) – are required to hold an additional capital buffer, which arguably makes them even safer. Unlike the smaller regional banks, the SIFIs have only modest exposure to the troubled commercial real estate sector. As my colleague Jonathan LaBerge has documented, big banks have only 6% of their assets tied up in commercial real estate compared to 25% for smaller banks (Table 2). Chart 7US Banks: Better Capitalized Today Than Right Before The Financial Crisis US Banks: Better Capitalized Today Than Right Before The Financial Crisis US Banks: Better Capitalized Today Than Right Before The Financial Crisis Table 2Most US Commercial Real Estate Loans Are Held By Small Banks Election Fireworks Election Fireworks The largest US banks have more exposure to residential real estate than to commercial real estate. The US housing market has been firing on all cylinders recently. Single-family housing starts were up 24% year-over-year in September. Building permits and home sales are near cycle highs. The S&P/Case-Shiller 20-city home price index rose 5.2% in August, up from 4.1% in July. The FHFA index surged 8.1% in August over the prior year. Homebuilder confidence hit a new record in October (Chart 8). Homebuilder stocks are up more than 20% versus the broad market this year. Chart 8US Housing Market: Firing On All Cylinders US Housing Market: Firing On All Cylinders US Housing Market: Firing On All Cylinders According to TransUnion, consumer delinquencies have been trending lower across most loan categories (Table 3). Notably, the 60-day delinquency rate on residential mortgages stood at 1% in September, down from 1.5% the same month last year. Table 3A Snapshot Of Consumer Delinquencies Election Fireworks Election Fireworks The Forbearance Time Bomb? Some investors have expressed concern that various pandemic-related forbearance programs are distorting the delinquency data. Reassuringly, that does not appear to be the case. Summarizing the results from the latest round of earnings calls with top bank executives, BCA’s Chief US Investment Strategist Doug Peta wrote: “Last week’s calls assuaged our concerns … It now appears that consumer requests for forbearance at the outset of the COVID-19 outbreak were analogous to businesses’ credit line draws: exercises of emergency options that turned out not to be necessary, and are on their way to being unwound with little ado.”1 Banks Are Cheap From a valuation perspective, relative to the broad market, US banks trade at one of the largest discounts on record on both a price-to-book and price-to-earnings basis (Chart 9). Earnings estimates are also starting to move in the banks’ favor. Relative 12-month forward earnings estimates for US banks are trending higher even against the tech sector (Chart 10). This largely reflects the expectation that bank earnings will grow more quickly than other sectors in 2021/22. Chart 9Bank Stocks Are Cheap Bank Stocks Are Cheap Bank Stocks Are Cheap Chart 10Bank Earnings Estimates Are Catching Up Bank Earnings Estimates Are Catching Up Bank Earnings Estimates Are Catching Up   A Few Words About Global Banks Chart 11Euro Area Banks Have Fared Especially Badly Since The GFC Euro Area Banks Have Fared Especially Badly Since The GFC Euro Area Banks Have Fared Especially Badly Since The GFC Chart 12Banks: A Low Bar For Success Election Fireworks Election Fireworks Banks in a number of markets outside the US face greater structural challenges than their US counterparts. Most notably, euro area bank earnings remain well below their pre-GFC highs (Chart 11). That said, investors are not exactly expecting European bank profits to recover to their glory days anytime soon. Chart 12 shows that if euro area bank EPS were to simply go back to last year’s levels, banks would trade at 5.4-times earnings. This implies a very low bar for success. Investment Conclusions Stocks have run up a lot over the past few days on fairly weak breadth. A short-term pullback would not be surprising. Nevertheless, investors should remain overweight global equities versus bonds over a 12-month horizon. The combination of ongoing fiscal and monetary support, together with a vaccine, will buoy global growth. As Chart 13 shows, it’s rare for stocks to underperform bonds when the global economy is strengthening. Chart 13Stocks Rarely Underperform Bonds When The Global Economy Is Strengthening Stocks Rarely Underperform Bonds When The Global Economy Is Strengthening Stocks Rarely Underperform Bonds When The Global Economy Is Strengthening Chart 14Value Stocks Typically Do Well When Economic Activity Is Picking Up Value Stocks Typically Do Well When Economic Activity Is Picking Up Value Stocks Typically Do Well When Economic Activity Is Picking Up   Value stocks typically do well when economic activity is picking up (Chart 14). That said, we are less sure about when the inflection point in the value/growth trade will arrive. As we have noted before, the “pandemic trade” benefits growth stocks, while the “reopening trade” benefits value stocks. For now, the number of new infections has not shown signs of peaking in either the US or Europe (Chart 15). Investors should continue monitoring the daily Covid data and be prepared to increase exposure to value stocks when clearer evidence emerges that the latest wave of the pandemic is cresting.   Chart 15The Number Of New Cases Continues To Rise Globally... But Mortality Rates Are Lower Than Earlier This Year Election Fireworks Election Fireworks Chart 16The Dollar Is A Countercyclical Currency The Dollar Is A Countercyclical Currency The Dollar Is A Countercyclical Currency As a countercyclical currency, the dollar should weaken next year as policy remains accommodative and pandemic risks recede (Chart 16). EM Asian currencies are especially appealing. A hiatus in the trade war should allow the Chinese yuan to strengthen even further. This will drag other regional currencies higher. Peter Berezin Chief Global Strategist peterb@bcaresearch.com Footnotes 1  Please see US Investment Strategy Weekly Report, “The Big Bank Beige Book, October 2020,” dated October 19, 2020. Global Investment Strategy View Matrix Election Fireworks Election Fireworks Current MacroQuant Model Scores Election Fireworks Election Fireworks