How the COVID vaccines affect the economy and the markets

COVID-19 continues to be a headline event around the world. A positive development is that an increasing number of headlines have to do with the rapid implementation of vaccines.

The pandemic created significant economic challenges dating back to early 2020, including a brief but very steep recession. Starting in the second half of last year, the economy rebounded and continues to show improvement. Rapid development of vaccines that demonstrate an ability to provide a high degree of immunity from COVID-19 is likely playing a significant role. Versions of the vaccine developed by several pharmaceutical companies have received emergency authorization and are actively being distributed. This has raised hopes for a positive reaction across the U.S. economy.

What should investors expect as the world continues to juggle both a persistent pandemic and the continued rollout of vaccines designed the stem the tide of COVID-19? Investment leaders from U.S. Bank offer their assessment.

The question of vaccine distribution and timing

With the vaccines from Pfizer-BioNTech, Moderna and Johnson & Johnson now being widely distributed, the question is how quickly can that result in something approaching a return to a “steady state” for the economy. The more widespread the administration of vaccines, the better the result is likely to be for the economy.

“Investors remain hopeful that by late in the second quarter or during the third quarter of 2021, vaccines will reach a significant percentage of the population,” says Eric Freedman, chief investment officer at U.S. Bank. The markets will be closely watching other factors as well, such as how the global supply chain holds up, logistical management, the order in which vaccinations are provided to various segments of the general population and the impact of potential health complications. “The markets continue to assume that vaccines will make a serious dent in COVID-19 before the fourth quarter of 2021,” says Freedman.

Are stock markets too far ahead?

Stock markets are generally considered a forward-looking indicator of the underlying economic environment. That seems to be the case as the Dow Jones Industrial Average, Standard and Poor’s 500 and NASDAQ Composite indices have all surpassed record levels in the opening months of 2021. “The market rally began in an environment of rising infections in the U.S.,” notes Rob Haworth, senior investment strategy director at U.S. Bank. “Investors looked right through those troubles and focused on the promise of economic growth in 2021 and beyond,” Haworth says investors have been focused on corporate earnings. “The market’s recent rebound is really about expectations for the profit picture to continue improving,” he suggests.

Some estimate that at least 70 to 80 percent of the population needs to be vaccinated to subdue the virus across the broader population. Haworth believes markets will closely watch the pace of the vaccine rollout. “The faster we get a large segment of the population vaccinated, the faster we return to some form of economic normalcy,” says Haworth.

For the remainder of the first half of the year, markets may be well positioned. “Companies should be able to generate favorable financial performance when measured against the first half of 2020,” says Tom Hainlin, national investment strategist for U.S. Bank. He believes the bigger questions revolve around how the economy responds in the second half of the year, assuming a successful rollout of vaccines. “We remain optimistic about the prospects for the economy later in 2021,” he adds.

Other factors that could have a bearing on stock market performance are inflation and interest rates. Both have risen so far in 2021, and if that trend continues, says Haworth, it could make stocks somewhat less attractive than if inflation and interest rates remained at very low levels.

In the meantime, challenges persist

While vaccines draw major headlines and significant interest, the reality is that the U.S. and much of the world are still contending with a major health challenge. There’s a general understanding that the vaccine rollout is a long-term proposition that doesn’t resolve the immediate challenge of trying to tamp down the impact of COVID-19. This is borne out in continued high infection rates in some states and in various regions of the world.

Notable economic issues persist as a result. “The federal government has played an important role in providing a fiscal bridge,” says Hainlin. Three different stimulus packages have passed in a year’s time, providing significant government support to the economy. The legislation included direct payments to most Americans, expanded unemployment benefits and financial backing for business owners. This may temper, but not fully offset, the economic headwinds many people and businesses continue to face.

While the U.S. economy appears well positioned for a continued economic recovery, that’s not consistent across the globe. Notably, Europe and parts of South America continue to be hard hit by the pandemic. Vaccine rollout has been slower in many parts of the world than is the case in the U.S. “This may limit the upside potential for companies that generate a good portion of their earnings from overseas markets,” says Haworth. “Many overseas nations will be slower to see economic recovery.”

What’s next for the economy?

As the economic recovery continues, there are longer-term issues to be considered, particularly among specific segments of the economy.

Freedman believes investors are closely watching consumer trends and business practices to see what carries on in a post-pandemic world. “Will we see a dramatic change in behavior? Will certain sectors be disproportionately rewarded or penalized by what’s happening?,” Freedman wonders. “We expect some changes within commercial and residential real estate, consumer spending habits, and how businesses rethink their marketing strategies. We will continue to monitor how these changes may yield investment opportunities.”

COVID-19 may have helped accelerate business trends that were already underway. Haworth points to examples such as an uptick in retail bankruptcies involving mostly companies that were dealing with significant challenges. Another area he believes bears close watching is the demand for office space. “There’s a possibility that demand could fall in central business districts as many employees begin to work from home more regularly.” This would have a dramatic impact on commercial real estate.

Haworth also notes a boost in demand for single family homes from millennials and a potential permanent decline in business travel given the increased use of technology to connect with business associates. This could have an impact on the airline industry and other parts of the hospitality market.

Making plans for the year ahead

There are industries that may be positioned to permanently benefit from changes that took effect with the onset of the pandemic. “Cloud computing and video streaming are services that are likely to continue to grow their businesses even when some sense of normal returns,” says Hainlin. Online retailing, already a growing trend, may have solidified its position in the past year.

Yet it may take time to fully delineate winners and losers when the “steady state” returns. When that time comes, headline events may take a backseat, and the typical market fundamentals such as corporate earnings are likely to become more predictive of investment performance. Individuals should continue to focus on a long-term, well-diversified investment strategy that is consistent with their tolerance for risk.