November raised investor hopes, but will the rally be sustained?

Coronavirus vaccine announcement and ending of US elections tremendously boosted investor optimism in November, as global equities experienced one of the best months on record;
Positive sentiment and rally in risky assets may continue until next year. But as major risks still remain present, investors should be warned how previous occasions of excessive optimism has ended.

From seasonal perspective, November is usually quite positive month for equities and other financial assets, especially so in years when US presidential elections are held and become over. However, in 2020 November turned out to be even more exceptional, as global equities managed to show one of the best monthly performances with MSCI ACWI rising in EUR terms by 9.3%.

Global equities (MSCI ACWI) monthly performance in EUR

Source: Bloomberg

Several factors contributed to such powerful result, but probably most important trigger was announcement by several companies, that effective vaccine against coronavirus has been developed and vaccination of population could be started as early as mid‑December. Investors, who were rather depressed by the end of October by prospects of prolonged lockdowns in Europe and potentially USA, received vaccine news incredibly well, as it allows expecting that lives of people and global economy would return back to normal conditions much sooner than it was feared.

Not surprisingly that major winners in November turned out to be cyclical sectors and ideas, which were particularly affected by negative economic developments at the beginning of the year. Equity prices of these companies until November have only moderately recovered March losses, as their financial performance still struggles to improve. These sectors include energy, airlines, hotels, cruise lines, grocery stores, real estate and others.

Performance of lagging industries in 2020

Source: Bloomberg

On the contrary, best performers of 2020 – FANMAG stocks were rising at rather moderate pace, still remaining more than 5% below their late August levels, and leading 2020 index Nasdaq‑100 being able to surpass late summer peak only in early December. So in essence, what we are witnessing in November is lagging sectors trying to catch up with leaders from previous months, as massive rotation is taking place.

FANMAG change in market capitalization

Source: Bloomberg

Apart from vaccine, it is also worth mentioning outcome of US elections. Though it is hard to estimate whether reaction of financial markets in case of Donald Trump victory would be less strong compared to how markets have reacted to Joe Biden win, one thing for sure – investors became significantly relieved, that elections were over and happened rather peacefully and without major excesses. It was feared beforehand, that as US society has become somewhat radicalized in recent years with social tension growing between democrat and republican supporters, election results may bring some social unrest and even riots on streets of major US cities.

However, even though Donald Trump is still not accepting election results, the rest of population taking democrat candidate victory without significant problems, and election risks are being reduced.

Thus vaccine news and election resolution as well as absence of new major economic lockdowns introduced in November, significantly boosted investor optimism on future economic prospects. According to influential AAII survey, large part of investors, who for the most part of 2020 remained bearish, finally reversed their view and became bullish, in fact, most bullish since January 2018. The same story is told by the data on new money flows into equity mutual funds and ETFs, as these funds also witnessed highest inflow of funds since January and March 2018.

AAII sentiment survey vs S&P-500

Sources: Bloomberg, AAII

ICI mutual fund and ETFs equity flows vs S&P-500

Sources: Bloomberg, ICI

January 2018 is actually interesting for comparison, as euphoria back then coincided with start of economic slowdown. As a result, global equities ended their two year rally, afterwards not being able to make new highs until December 2019. And if we mention last year, it is worth saying that economic situation back then also remained weak, but equities continued to rally on hopes of trade deal between USA and China, as it was hoped it would accelerate economic growth. In mid‑January 2020 trade deal was finally signed, global equities made new all‑time highs and investors were very optimistic on future prospects of financial assets. However, just one month later we witnessed one of the most brutal market crashes in history. Replace January with November and “trade deal” with “vaccine” and there definitely becomes something to think about.

So should we be worried about such excessive optimism? Not necessarily, if vaccination is successful, lockdown measures are lifted, without new restrictions being introduced, and all damages from this year getting recovered leading to healthy economic growth, rally may continue for more months to come. But the key point is, just because there is now strong rise in prices of financial assets and majority of investors do not expect bad things to happen, it does not mean there could not be another major crash. Last three years in financial markets prove this point rather clearly.

MSCI ACWI index (USD)

Source: Ned Davis Research

Finally it is worth mentioning that major risks still remain. First of all, by many fundamental measures, risky assets continue to remain most expensive in last twenty years. Secondly, fiscal stimulus bill in USA is still not being introduced, so, if despite all the vaccine announcements USA will have to close economy once again, economic consequences could be severely negative. Thirdly, even under positive scenarios it is not clear, if economy will be able to return to pre‑COVID levels as bankruptcies and unemployment levels still remain exceedingly high, and risks of excess capacity and reduced demand remain present. Equity markets, meanwhile, are updating all‑time highs, as if nothing of all this matters. But maybe this is exactly the time when extra caution would not hurt.

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