Financial markets have staged a spectacular recovery from their March 2020 crash based on unprecedented but temporary monetary and fiscal stimulus but also trust that vaccines would eventually eradicate COVID. The forthcoming northern hemisphere winter coronavirus season risks a reset of high vaccine expectations at a time when central banks and governments have already shot their bolt. This time we could have an economic freeze from which markets may not so quickly rebound.
Although the summer “Delta” variant may now be near peak, the more significant risk will come at the onset of winter. Recent rising infections in the “double jabbed” have highlighted the absence of immunity provided by the vaccine to infection or transmission. Although - as with flu - vaccines may have a useful role in managing the pandemic, it now seems certain that mass inoculation will fail to eradicate COVID.
There is now a crucial debate around the degree to which vaccine efficacy also fades against serious illness. There is still a consensus that the inoculated are protected, but we know from studies in Israel and the UK that the “double jabbed” are not immune to serious disease progression. Only the Israeli authorities are currently publishing timely data on what proportion of recent hospitalisations are amongst the unvaccinated. These are not entirely comforting.
Governments are now hoarding extra vaccine shots in anticipation of fading vaccine efficacy this winter. We do not know whether these “booster” shots will work less well than the original “double jabs” but any efficacy is unlikely to be any longer lasting. We also do not know whether there is a relationship between COVID variants and the vaccines, whereby new variants develop immunity from the vaccine. We should however not expect “Delta” to be the last variant or it to somehow have been uniquely resistant to protection offered by inoculation.
The recovery plan in those industries hit hard from COVID– such as travel, leisure, retail, offices – was to cut cash burn through use of furlough and wait for trading conditions to return to normal once the population was vaccinated. If COVID cannot be eradicated and there remains a serious threat to the vaccinated then governments may seek to impose annual winter mobility restrictions. Investors are likely to be less willing to rescue companies with business models that are permanently impaired.
The willingness of governments to provide generous support to hard-hit industries - funded by increased borrowing - was also based on the assumption that COVID restrictions would prove temporary. We cannot assume the same largesse will be available to manage a public health crisis with no determinable end. Without support wholesale industry bankruptcies would be inevitable, potentially leading to a credit crunch.
We also now know that COVID restrictions can be both deflationary in restricting demand in some industries but highly inflationary in curtailing supply in other areas of the economy. These shortages from shipping to semiconductors will continue to endure. Profit margins in companies where demand is relatively unaffected by the pandemic could continue to be squeezed. Central banks such as the Federal Reserve which is currently discussing the degree to which monetary stimulus is withdrawn may be forced to confront stagflation rather than deflation.
There is therefore no guarantee that central banks would ride to the rescue of financial markets in any repeat COVID crisis. “Quality” companies or even government bonds would necessarily be safe from stagflation. It now makes sense to hedge through increased short exposure to risky parts of the market, particularly as the duration of the doomsday scenario risk is itself limited by seasonality.
Financial markets have been fully invested in the “vaccine solution” for COVID which now looks at best tenuous. COVID is now endemic, there is no certainty over the protection offered by inoculation and no government “Plan B”.
Winter is coming. It now makes sense to hedge.
Barry Norris
Argonaut Capital
September 2021