Market leadership shifting to financials and cyclicals, says Jim O'Neill

By Nikunj Dalmia

Keeping a close eye on inflationary pressures and reliable surveys of inflation expectations together with the pace of economic recovery are going to be really important as we go into 2021, says Jim O'Neill, Chairman, Chatham House.

Just when things got muddy late last week because of confusing news from AstraZeneca, it looks like Pfizer managed to grab a vaccine deal!
It was a pretty special day with the news that the UK regulator has independently approved the safety of the Pfizer vaccine and probably by coming Monday, people will begin to be actually vaccinated. Last time, there was a difference between vaccine discovery and vaccination. But now, at least in terms of the process, it is real and we can look forward to the same kind of process happening in many countries as we go towards the end of the year and the beginning of 2021.

I am sure we will discuss it further but the AstraZeneca one remains very important. One has to hope that they will get through the approval process because it is important for two particular reasons: one, it is cheaper than the Pfizer one and two, very significant amounts of it can be transported a lot more easily (than the Pfizer drug which has temperature issues) in large parts of the emerging world. This is good news and justifies the optimism in global equity markets.

Do you think a strong vaccine politics has started? The Russians are claiming a breakthrough and sharing numbers of 100,000 people who have been already vaccinated. The Chinese, the Americans and others are also claiming that they have got an antidote.
I am sure some countries will find it irresistible to play the national bravado angle about where the vaccine has come from. But frankly, this is a genuine win-win situation. The more vaccines we get from more countries and particularly if they have been approved by truly independent regulators such as the UK one, the better it is for everybody. To some extent, it does not really make any difference where the vaccine is being created. What is important is that it gets distributed as equitably and as quickly as possible all over the world.

The Pfizer vaccine which is being rolled out first in the UK is primarily based around the capabilities of a German based biotech firm and so there are all sorts of international collaboration going on in all these vaccines anyhow. The AstraZeneca one as you probably know involves a significant amount of production at a plant in India and I am pretty sure that means that India will be one of the earliest beneficiaries of that.

In a broader sense, I would also like to reiterate that in an era of deglobalisation, the speed and the cooperation going on amongst healthcare research firms of pharmaceutical companies demonstrate that globalisation is alive and well.

Equity markets always look forward. Can I say that stock markets or financial markets are factoring in the vaccine discovery news?
I think you can. I have touched on this with you a couple of times since April. It has been quite apparent to me that the equity markets have been a bit more logical than many people often talk about because they have traded the combination of the rate of change of the infection curve, the prevention curve and crucially the vaccine discovery and implementation curve. What has been crucial about the past few weeks is while we have this huge global rally in November, I am right in saying that possibly the strongest single monthly rally in modern times is because the three vaccines appear to have been independently verified to be effective by western countries and now with this news of it being rolled out in the UK, it seems a finite end to this crisis, especially in the developed countries, is possible.

That will mean that many sectors that have been brutally shut down because of the pandemic have a serious chance of having some kind of vaguely normal life again by the middle of next year. Not surprisingly, many airlines stocks have risen significantly and this is all a very sensible reflection of the equity markets smelling a very vigorous recovery for those sectors that have essentially been shut down for the best part of 2020.

Equity markets had enjoyed a strong bull market from 2016 to 2019. If a vaccine is discovered, it may simply take us back to levels of 2019 and at that time, equity markets were due for a correction!
Markets always evolve in response to all sorts of ongoing changes of information. They discount the future probably better than many of us. I think there is a whole complex combination of things going on here. First of all, we might be in the process of global equity leadership shifting away from the United States to the rest of the world.

Second is linked to that probably because in response to the pandemic, we have seen that this remarkable fiscal and monetary stimulus is something that in 2019 markets have no reason to anticipate. We are seeing the pursuit of a fiscal stimulatory policy in all parts of the developed world and many others that many people would not have dreamt of as being a feasible choice back in 2019. Amongst the reasons why this is so important is that while a lot of people have been forced to not work and in many cases have lost their jobs, there has been a huge amount of income support provided to people during this period.

Crucially, the personal savings rate in many parts of the world have risen to levels that one would have not dreamt and that could have been the case in 2019, which means it is more than a presumption that people have become less concerned as more and more people get vaccinated and the likelihood of an acceleration in consumer spending with their business investment in 2021 is quite logical. Where I do share the implicit question that you are throwing at me is that you cannot ever ignore valuation.

If we start to see a different pattern of behaviour emerging in the bond markets and central banks start to be less friendly, then one would want to become a lot more cautious about some aspect of the equity markets. Some of this is already playing out in the past fortnight. On some days, the leaders of the past few years -- particularly the US tech sector -- have a bad day which has been quite rare in the past few years. We are also seeing leadership shifting to financials and other forms of cyclicals that would probably be beneficial from a change in the interest rate structure. I would imagine that that part of the equity market is going to continue to be a bit more tricky than it has been for quite some time. It is an opportunity but people have to be careful in terms of sector allocations.

You expect equity markets to become much more widespread and it may just move outside the comfort zone of the US. If you have to pick your spots outside the US, which way would you lean?
I hate to endorse the phrase emerging markets and we have just gone past the 19th anniversary of the BRIC acronym. But I find it hard to resist thinking that the environment is supportive of so called emerging markets. This extraordinarily friendly policy is seen from many central banks around the developed world, particularly the US. On top of responding to the pandemic, in August, the Fed chose to shift its policy bias towards deliberately seeking inflation above 2% which is an important philosophical and practical change and essentially implies that unless inflation picks up significantly, the Fed is going to be very generous for quite some time.

We have got some versions of the same thing happening in Europe and elsewhere and as a result of it, the dollar is under pressure, commodity prices are accelerating daily and this suggests a very supportive environment for both the debt and equity markets of the so-called emerging markets.

Do you think inflation is coming?
When I think about the things that could go wrong next, I find myself thinking that perhaps we should not forget about the inflation threat when we look at the generosity of monetary and fiscal policies.

Let me start with fiscal policy. One of the things I see repeatedly being said by many western governments is that we do not need to worry about debt because the debt servicing level is so low. It has been commented on in the newspapers in the UK that though the difference compared to one year ago is saving the UK government 20 billion pounds a year in terms of interest rates cost servicing. But if we were to see inflation starting to rise and the markets becoming more concerned about that fiscal policy, operators would have to suddenly start thinking that it was not such a free lunch as they currently think and not the least because if we go to monetary policy, that might cause central banks to suddenly start being a bit more careful.

So keeping a close eye on actual inflationary pressures and reliable surveys of inflation expectations together with the pace of economic recovery are going to be really important as we go into 2021. I say that in particular because there is a reasonable chance from what I can see of consensus forecasts that economic growth might actually accelerate in 2021 more than what I see most people are suggesting.

What are the chances that we could be staring at another round of tariffs and trade war between the US and China? The view in the market is Donald Trump is going and trade wars are coming down.
Yes, that is another thing that is going to be around for quite some time.It is complex. What the markets are pleased or relieved about currently is that under Biden, the US is going to try and engage through the established international institutions, which is something I personally welcome highly. One of the things which has been particularly bothersome under the Trump years is essentially a deliberate effort to pull apart the whole international organisational structure whether it be the WHO, the WTO and even the G-7 and the G-20 which Trump has treated by and large with disdain.

What is welcome is that Biden is making it clear both in what he says and through his appointments that the US is going to be at the forefront of trying to re-establish the importance of these institutions and more importantly to try and strengthen them. Whether that means the US is going to be less concerned about issues involving China is a completely different matter. My own impression is that the Chinese are probably more concerned about the Biden administration than they were with Trump and not least because they think the US will spend more time trying to build alliances with democracies all over the world in trying to confront governments that are not democratic about some aspects of fairness -- be it be elements of international trade or issues to do with security.

There are small signals that could be interpreted that the Chinese are starting to adjust their own behaviour in order to be able to cope with a more concerted thoughtful approach to stop Chinese behaviour in a way that the Western world broadly does not like. For example, the very big messages they keep sending about their stance on climate changes being wrong and the way RMB has been allowed to appreciate. They seem to be at the margin encouraging more and more opening of their markets.

These are all things that one would expect would be part of a more liberal approach coming out of Beijing. But obviously, there are going to be things which should be a lot trickier but I would expect the Biden administration is going to be pushing China about them and so there will be periods of confrontation going forward.

Does the fact that Janet Yellen has been handpicked for the core team to represent the Biden administration clearly shows the kind of monetary policy they are likely to follow?
Janet Yellen is one of the names I was implying when I said if you look at the team that Biden has picked. I thought Janet Yellen did an extremely good job when she was chair of the Fed. She brought a slightly more lateral way of thinking and through her manner and demeanour was quite modest in an understated way. She is widely respected all over the international community and I think she is a symbol of how the Biden administration plans to engage. She has certainly shown signs historically of not only embracing the established forms of trying to pursue international policy coordination but also in terms of handling complex domestic challenges. It is a highly welcome appointment having Janet Yellen in that seat.