How COVID continues to impact the markets and economy

Updated August 26 | Market news

Although many hoped that by this point COVID-19 would be mostly in our past, the pandemic has surged again in the U.S. and in many parts of the world. Because of that, it continues to be a consideration for investors as well.

There was significant improvement in the first half of 2021 as the distribution of what have proven to be very effective vaccines (approved on an emergency authorization basis) gained momentum. That appeared to contribute to a dramatic reduction in COVID-19 infections in America and other regions across the globe where vaccines were being utilized.

Yet progress in vaccinating the remaining group of unvaccinated, eligible Americans slowed through much of the summer. At the same time, the emergence of the Delta variant has led to a reversal of what had been a favorable trend. Infection rates, hospitalizations and deaths from COVID-19 began to climb significantly. Those who are not yet vaccinated have been the most susceptible to infection and for many, to serious illness or death.

How might this evolving environment impact the markets and economy? Investment leaders from U.S. Bank offer their assessment.

Vaccine progress slows while the virus picks up

There’s been significant anticipation of the time when the world has overcome the pandemic and can return to something approaching the “normal” state that existed before. Vaccinations appear to be a key to achieving this status. “The markets continue to assume that vaccines will make a serious dent in COVID-19,” says Eric Freedman, chief investment officer at U.S. Bank. In fact, the progress to date in domestic vaccine distribution may well explain the stock market’s continuation of a strong rally that began in March 2020.

Still, the U.S. has not yet achieved what would be considered a level of immunization that could ultimately defeat the virus.

COVID-19 Full Vaccination Levels in U.S.1

Age group

% age fully vaccinated

Total U.S. population

52%

Population 12+ years

60%

Population 18+ years

63%

Population 65+

81%

It is not entirely clear what percentage of the population needs to be vaccinated to reach a point where a broad degree of immunity from COVID-19 is achieved, but a target many have set is 80 percent. An increasing concern is that vaccination progress slowed considerably over the summer. A large group of Americans appeared to be hesitant about receiving the vaccine. As a result, immunity on a societal scale remains elusive.

A major story that emerged more prominently in mid-2021 is the rise of the Delta variant of COVID-19. It is now the predominant strain of the virus. Of particular concern is that it appears to spread more rapidly than previous versions. The greatest impact is on the unvaccinated segment of the population.

Two additional factors have emerged as well. The first is that the federal government approved the COVID-19 vaccine developed by Pfizer-BioNTech for full licensing status, a major upgrade from its previous emergency authorization status. This may entice more unvaccinated people to overcome their concerns and get the vaccination. It also may lead to more corporations and organizations implementing vaccination mandates for staffs, patrons, etc.

The second is that the U.S. government has announced plans to offer “booster” shots to those who are already fully vaccinated to increase their immunity. This will present new rollout challenges and is an indication that shots received earlier may have a diminishing impact in terms of providing protection against current and future variants of the coronavirus.

Not yet back to normal

Investors are anxious to see the economy return to something resembling its pre-pandemic status. “We’re not there yet,” says Tom Hainlin, national investment strategist, U.S. Bank. “The Delta variant is a reminder of that. It is creating material concerns about when we will return to normal.” Hainlin is encouraged by the performance of the available vaccines against this variant, but notes that some caution is warranted if a new variant emerges that the vaccines can’t address with the same reliability. “We’re watching to see if the strains force countries and states to restrict movement, close schools and businesses and so forth.” So far, shutdowns have mostly been avoided, but as the infection numbers increase, this will be a trend to closely monitor.

At the same time, the U.S. economy has demonstrated significant strength. Gross Domestic Product (GDP), the primary measure of the economy’s strength, grew by an annualized rate of 6.4 percent in the first quarter. It followed that up with annualized growth of 6.5 percent in the second quarter.2 It was encouraging news to investors, who continued to propel major stock market indices such as the Dow Jones Industrial Average and Standard & Poor’s 500 to record levels.

How markets are trending

Investors seemed to adjust to the COVID-19 news quickly. After stocks nosedived 33 percent over a five-week period in February and March of 2020, the rebound has been remarkable. “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.” He points out that the market’s recovery was zeroed in on expectations for continued improvement in corporate profits.

“In a sense, investors considered 2020 to be a bad year to write off, and looked right through that to discount future earnings,” says Hainlin. “They also reacted to strong fiscal and monetary stimulus.” This included trillions of dollars in direct stimulus to taxpayers and businesses from multiple COVID relief plans passed by Congress and significant monetary stimulus by the Federal Reserve.

Hainlin notes that investors continued to demonstrate confidence in the ability of companies to meet profit expectations, and to this point, they haven’t been disappointed. “We’re seeing a stronger than expected recovery reflected by corporate earnings, so it isn’t a surprise that markets have set new records in the process,” says Hainlin.

The direction of stocks going forward is a mixed bag. Hainlin notes that the stock market today can be divided into three buckets:

  • Cyclical growth stocks that perform well when the economy recovers but tend to lag when growth slows. This includes energy, financials, materials and industrial stocks.
  • Secular growth stocks representing industries that are able to grow regardless of the environment, such as technology, communications services and selected health care companies.
  • Defensive stocks that outperform other parts of the market when the economy is slowing or in recession. These include utilities, consumer staples and some health care stocks.

Hainlin points out that given the strength of the economy, investors have rotated between the first two groups of stocks so far in 2021. He believes cyclical and secular growth stocks will continue to lead the market in the near term.

As for bonds, Hainlin doesn’t anticipate any significant upturn in interest rates as long as the pandemic remains a threat to the economy. He anticipates that the Federal Reserve will need to hold the line on the interest rates it controls with COVID-19 risks still prevalent. That may provide some stability for the bond market.

Risks to watch going forward

Hainlin believes there are several risks that warrant closer watching:

  • The potential that the Delta variant or future variants will ramp up and force more restrictions that slow the pace of economic growth.
  • A potential policy mistake by the Federal Reserve as it weighs its options to keep inflation in check while avoiding steps that could slow the economic expansion. This could include raising interest rates too quickly and stifling the recovery, or waiting too long to raise rates, resulting in a spike in inflation.
  • Federal government spending increases to a point that investors begin to view U.S. Treasury securities as carrying a greater risk, driving interest rates higher.

While these are potential negative scenarios that are not likely to occur, Hainlin says they are concerns worth monitoring.

In the meantime, patience will be needed as we continue to wait for the emergence of a “post-pandemic” state and a more normal economic cycle. According to Freedman, “we expect some changes within consumer spending habits, and how businesses rethink their marketing strategies. We continue to monitor how these changes may yield investment opportunities.” It may take more time to fully delineate what stocks will be best positioned for a post-pandemic environment that remains elusive in the near term.

Talk with your U.S. Bank wealth professional to make sure your portfolio is positioned utilizing a long-term, well-diversified investment strategy that is consistent with your tolerance for risk.

Diversification and asset allocation do not guarantee returns or protect against losses.

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