Overview

Overall, recent developments arguably skew more positive than negative:

• Critically, the COVID-19 infection numbers continue to fall with remarkable speed.
• Two new vaccines have reported positive results and are seeking government approval.
• The supply of vaccines appears set to increase via a mix of factory retooling, outsourcing and the aforementioned new vaccines.
• While many service industries remain deeply depressed, global manufacturing is actually booming.
• Economic surprises continue to tilt in a positive direction despite the recent economic stall.
• Macro risks for the year ahead skew less negatively than a quarter ago.

There are nevertheless a few new negatives:

• One of the new vaccines had passable but arguably underwhelming results.
• The rate of inoculation has been slower than desired, and highly inconsistent across countries.
• K. manufacturers are reporting some Brexit supply chain pain.

Virus developments

Global amelioration

The pandemic has now reached the unfortunate milestone of 100 million total COVID-19 infections since the onset in late 2019.

Despite this, the main pandemic theme of the past few weeks is one of remarkable improvement. The pace of global infections has recently fallen from around 750,000 new cases per day to approximately 500,000 per day (see next chart). The fatality numbers are also declining slightly. This trend will likely become more visible over the coming weeks.

Global COVID-19 cases and deaths

As of 01/31/2021. 7-day moving average of daily new cases and new deaths. Source: WHO, Macrobond, RBC GAM

This is not the first time that the global infection numbers have staged a tentative improvement. But the global transmission rate has now fallen to its lowest level since the onset of the pandemic – and substantially below the key threshold of one (see next chart).

Global transmission rate hovering around key threshold of one

As of 01/31/2021. Transmission rate calculated as a 7-day change of underlying 7-day moving average smoothed by a 14-day moving average of new daily cases. Source: WHO, Macrobond, RBC GAM

What is even more remarkable about the recent improvement is its breadth. Most countries are enjoying this improvement, as per the many countries with transmission rates below one (see next chart).

Transmission rate over one means COVID-19 accelerating

As of 01/31/2021. Transmission rate calculated as a 7-day change of underlying 7-day moving average smoothed by a 14-day moving average of new daily cases. Source: WHO, Macrobond, RBC GAM

North American improvement

Canada and the U.S. have both continued to enjoy rapidly declining infection numbers. Canada has gone from approximately 8,000 new cases per day in early January to 5,000 now, with major provinces all participating.

COVID-19 cases and deaths in Canada

As of 01/31/2021. 7-day moving average of daily new cases and new deaths. Source: WHO, Macrobond, RBC GAM

The rate of improvement is similar in the U.S., having dropped from around 250,000 cases per day in early January to approximately 150,000 cases now (see next chart). The great majority of states continue to improve.

COVID-19 cases and deaths in the U.S.

As of 01/31/2021. 7-day moving average of daily new cases and new deaths. Source: WHO, Macrobond, RBC GAM

Success with the new variants

It remains a pleasant surprise that the two countries most seriously affected by the new, more virulent virus strains – the U.K. and South Africa – have continued to reduce their infection counts (see U.K. chart). It is clearly possible to control the virus even when it is 56% more transmissible. Improbably, these two countries have enjoyed a greater infection rate decline than almost any other.

COVID-19 cases and deaths in the U.K.

As of 01/31/2021. 7-day moving average of daily new cases and new deaths. Source: WHO, Macrobond, RBC GAM

The fatality rate should shortly begin to improve. Even if the new variant is 30% more fatal, the fatality numbers should still fall by a factor of three given that the infection numbers have fallen by a factor of four.

The U.K. has made serious economic sacrifices in pursuit of this achievement. It is curious that South Africa (see next chart) has not had to shut down as aggressively, despite a similarly large improvement. Perhaps it is benefiting from the onset of southern hemisphere summer?

COVID-19 cases and deaths in South Africa

As of 01/31/2021. 7-day moving average of daily new cases and new deaths. Source: WHO, Macrobond, RBC GAM

Israeli mystery

Israel is now in the spotlight, having made great strides in vaccinating its population – discussed in more detail later. But whereas it has been a pleasant surprise that the U.K. and South Africa have improved despite the presence of the variant, it has thus far been an unpleasant surprise that the Israeli infection numbers have failed to improve as enthusiastically as elsewhere – despite far more vaccines. In fact, the country’s numbers didn’t fall at all over the past few days (see next chart).

COVID-19 cases and deaths in Israel

As of 01/31/2021. 7-day moving average of daily new cases and new deaths. Source: WHO, Macrobond, RBC GAM

Why isn’t Israel reaping outsized benefits from its vaccine success?

Fortunately, it is not that the vaccines are failing. Those aged 60-plus who have received their first shot have already enjoyed a 60% decline in hospitalization.

There are a few plausible answers:

1. Although the country is making remarkable progress inoculating people, it is still fairly early. The second inoculation occurs three weeks after the first, and maximum protection isn’t conferred until two weeks after that. Fairly few Israelis have made it to this finish line, though many more will be joining them over the next few weeks.

2. Further underlining the matter of timing, the people who tested positive over the past week would have contracted the virus a week or two earlier. A decline in COVID-19 infections should happen with a lag in part due to the contours of the inoculation program, but also due to this testing lag.

3. Israel’s infection figures were seemingly deteriorating more quickly than most other countries before the vaccinations began. So, it could be that the vaccines have successfully prevented Israel’s daily infection rate from leaping several times higher, even if they have thus far failed to aggressively reduce the infections.

4. It may be that Israel’s vaccination success is instilling a false sense of confidence in the country. Some people may revert to more normal levels of activity even though they themselves have not yet been inoculated, or – if inoculated – even though the vaccine does not offer 100% protection. If this is the case, it is an important lesson for all countries to learn or the coming several months could be more difficult than they need to be.

It is unclear which factors dominate. The first three should resolve themselves shortly, such that we expect Israel’s infection and fatality numbers to begin falling sharply over the coming few weeks.

Contemplating seasonal explanations

In seeking to understand the spread of COVID-19, the precise relationship between social distancing measures and the spread of the virus has proven frustratingly elusive. There is certainly an important connection, but it does not explain everything.

Part of the problem is that estimating the amount of social distancing is challenging, not just because it isn’t clear how helpful wearing a mask is relative to closing a business, but also because most such decisions are happening at the regional level. This means tallying the effects for a single country is overwhelmingly difficult, let alone for the world.

But it would also appear that other variables are relevant to the spread of COVID-19. These other variables arguably include compliance with social distancing rules (which has likely declined over time), the amount of travel permitted between jurisdictions (now declining sharply), and even the weather.

This last variable – the weather – is particularly interesting. It would appear that COVID-19 spreads more easily as the weather cools and (of even greater relevance) the air becomes drier. This likely explains a significant chunk of the deterioration in the COVID infection numbers over the fall, particularly since the rules were actively becoming stricter at the same time.

But deeper thinking about seasonal effects reveals frustrating inconsistences. For instance, the common flu usually peaks in intensity during the winter – consistent with the notion that such diseases spread more easily in the cold and dry air. But the Spanish Flu of 1918—1919 famously experienced three separate waves, peaking in the spring of 1918, the fall of 1918 and the spring of 1919. In that case, the winter was not the peak. Instead, and to the extent the pattern wasn’t merely a coincidence, it would appear that cool but not frigid weather was best for spreading the virus.

It is a bit ominous, then, that the COVID-19 numbers have recently improved as fall has progressed to winter. Many countries have undeniably tightened their social distancing rules. But there is another competing and entirely plausible explanation – given the rapidity and near uniformity with which so many countries have simultaneously improved their virus counts. This hints that the virus could be operating like the Spanish Flu, and so somewhat less dangerous in the heart of the winter.

If true, we must be on guard against what would be a most disheartening spring wave in 2021. This theory could even help to explain how China reduced its infections so quickly last winter, while the rest of the world had considerably more trouble when the virus reached them in the spring.

Yet this seasonal explanation has its own flaws. In the U.S., the recent synchronized improvement in states with radically different climates such as Florida, California and New York argues it cannot simply be a function of the temperature going below freezing in January.

A third possibility is that the spike in infections recorded in December and early January was primarily a function of holiday season socializing. Perhaps the infection numbers would have been much lower over that time period otherwise, and we are now merely reverting to a more normal rate of infection after that distortion. While this idea holds for the likes of the U.S., Canada and the U.K., it fails to explain the spike in European infections well before the holidays.

This discussion has most clearly revealed that there are more questions than answers as to why the infection numbers spiked a few months ago, and why they have been coming down more recently. We will certainly continue to cheer their improvement and hope that the main reason is fewer social interactions and perhaps even nascent vaccinations. Yet we are cognizant that there may be other factors at play.

Vaccination developments

The world has now administered nearly 100 million vaccine doses globally, and the pace continues to accelerate. Thirty-six percent of all inoculations occurred in the last five days alone (see rising lines in the next chart).

Coronavirus vaccine doses administered

As of 01/31/2021. 7-day moving average number of new daily coronavirus vaccine doses administered per million. Source: Our World in Data, Macrobond, RBC GAM

Israel remains far out in front of other countries, with a remarkable 53.5 shots administered per 100 people. Recall that most vaccines require two shots per person, however, so one must divide by two to get a sense for the fraction of the population that has been inoculated. Other countries lag significantly behind, though the U.K. (14.1 per 100 people) and the U.S. (9.6 per 100 people) are also significantly ahead of most developed countries. While Europe lags, Canada is even further back in the developed-world pack with just 2.5 shots per 100 people (see next chart, which controls for people vaccinated rather than overall number of doses).

Share of people receiving at least one dose of the vaccine

As of 01/31/2021. Share of people that have received at least one dose of the COVID-19 vaccine calculated as a percent of the population. Source: Our World in Data, Macrobond, RBC GAM

Interestingly, and not shown in the chart, China has only reached 1.6 doses per 100 people. Of course, it confronts the unique challenge of having to inoculate an unfathomably large population. It also doesn’t have as urgent a need as most countries.

Another laggard and country not on the chart is Japan. Japan appears set to lag other developed countries significantly. In fact, it has decided not to begin inoculating its citizens until the vaccine-makers can prove that the vaccines are effective and safe for ethnically Japanese people. As such, the country will not begin its inoculation process until late February at the earliest – up to three months after some countries. This is also only five months before the Tokyo Olympics are scheduled to begin.

New vaccines

Two new vaccines have reported successful trials, and are now applying for governmental approval.

Johnson & Johnson vaccine

The long-awaited Johnson & Johnson vaccine announced a 66% efficacy rate at preventing moderate to severe cases of COVID-19. This is somewhat lower than the other western vaccines (roughly 90% to 95% efficacy rates), though the comparison is imperfect. The J&J results appear to exclude mild cases altogether. Given that the vaccine is reported to be more effective against severe cases than moderate ones, one might surmise that it is least effective against the omitted mild cases. Thus, the J&J efficacy rate would presumably be even worse if compared on an apples-for-apples basis with the other vaccines.

That said, the vaccine is still a worthy addition for several reasons:

1. While the J&J efficacy rate isn’t strictly comparable with the others, it reportedly reduces the frequency of severe cases – those that might kill someone – by a sharp 85%. This is a major accomplishment, and so long as the supply of vaccines is constrained, this is worth producing and distributing.

2. The J&J vaccine has several attractive qualities. It only requires a single dose – reducing the cost and logistical challenge of tracking people down for a second dose. It can be produced in large amounts. And it needn’t be stored at the extremely cold temperatures required by some of the others.

3. J&J is now testing a two-dose version. Given that its single dose has an efficacy rate similar to the protection provided after the first of the two jabs required by the other vaccines, this enhanced formulation could ultimately provide the same level of protection as the others.

4. The J&J vaccine had to combat the new U.K. and South African variants. To the extent that most vaccines appear to suffer a slightly reduced efficacy against the U.K. variant and a significant drop against the South African variant, this means that the J&J vaccine had to clear a higher hurdle than did the older vaccines tested last fall.

5. While it would have been preferable to include instances of mild infection in the J&J vaccine efficacy rate, the Pfizer and Moderna vaccines (but not the AstraZeneca vaccine) have also been criticized for their efficacy rate claims. They only recorded symptomatic positives in their trials. As such, they may have exaggerated their efficacy rates. It is unclear how J&J has handled this matter.

It is heartening that J&J reported the vaccine was 100% effective against hospitalization and death. But, in fairness, out of the roughly 120 positives in the vaccinated test group, the most likely outcome would have been zero deaths even if the underlying fatality rate had not changed.

Novavax vaccine

Novavax also announced its Phase 3 trial results. It announced a strong overall efficacy rate of 89% for its vaccine candidate. The vaccine is meant to go disproportionately toward emerging market nations. However, the U.S. has made a large 110 million dose order and Canada has requested an even larger (on a per capita basis) 52 million doses.

Promisingly, there were no severe infections among the vaccinated test group, though it should be noted that there was only one severe infection in the control group. So – as with the J&J vaccine – it is premature to conclude that it provides complete protection against the most adverse outcomes.

The raw efficacy rate of the Novavax vaccine makes it appear somewhat less successful than the Pfizer and Moderna vaccines. Yet, in actual fact it recorded a 96% efficacy rate against the original strain of the virus. That’s as good as the top-performing vaccines. Novavax also provides an 86% efficacy against the new U.K. variant and a 60% rate against the South African variant. Novavax plans to produce a booster that should increase the effectiveness of the vaccine against the South African strain.

More manufacturing capacity

Not only are more vaccines enjoying success, but the manufacturing capacity for existing vaccines is also rising.

1. Once Pfizer finishes retooling its European plants, it expects to be able to produce more vaccines. Reflecting this, it has promised to deliver 75 million additional vaccines to the EU during the second quarter relative to its prior schedule. Some of this will merely represent a catch-up effort after under-delivering in the first quarter. Yet it should nevertheless yield more overall production across 2021.

2. Sanofi has agreed to use its manufacturing expertise to produce another 125 million doses of the Pfizer vaccine, on top of Pfizer’s own production.

3. Novartis has now penned a similar production deal with Pfizer, though the specific amount it will produce is not known.

It is heartening that additional production capacity is coming online. This should help to speed the pursuit of herd immunity over 2021.

Vaccine security

Vaccine security is likely to be taken more seriously after a few isolated incidents in recent days. Anti-vaccination protests led to the temporary closure of an inoculation site in California.

Elsewhere, a suspicious package was sent to a vaccine plant in the U.K., forcing the temporary suspension of manufacturing.

The risk of theft is also not nil given that the vaccines will arguably be among the most precious commodities on the planet over the next year. Additional security around production facilities and the supply chain seems likely.

Economic developments

Economic surprises remain positive

Economic surprises – the extent to which economic data is better or worse than forecast – were incredibly negative in the earliest stages of the pandemic. They then bounced to unprecedentedly positive levels in the spring and summer as the economic rebound proved much faster than expected.

Subsequently, the economic surprises became incrementally less positive as the recovery settled down. However, contrary to popular imagination – and despite recent second-wave economic challenges – the economic surprises never fully retreated back to a neutral setting (see next chart). Instead, they have remained substantially positive.

Global economic surprises remain positive after wild swings

As of 01/28/2021. Source: Citigroup, Bloomberg, RBC GAM

This provides no guarantees about the future. But it represents at least a cautious endorsement of our view that above-consensus economic growth forecasts are likely the winning strategy for the year ahead. On this note, the International Monetary Fund’s new economic forecast upgraded the global growth outlook for 2021 relative to the quarter before.

Incredible financial conditions

Financial conditions have never been easier than today (see next chart). Financial conditions refer to the extent to which interest rates, credit spreads, the stock market and exchange rates support economic growth. Much of this is the result of incredible support from central banks and fiscal coffers, but none of this is likely to go away any time soon. The combination of ultra-low interest rates, extremely narrow credit spreads, high stock market valuations and – in the U.S. case, a softer U.S. dollar – should keep growth moving forward over the next year.

Global Financial Conditions Index hovers around record low

As of 01/27/2021 for U.S., 01/26/2021 for global. Source: Goldman Sachs, Bloomberg, RBC GAM

The recent experience provides a significant contrast to the global financial crisis. Then, financial conditions deteriorated and took several years just to normalize, let alone to become friendly. In contrast, the deterioration of financial conditions during the pandemic was extremely brief, and has since been replaced by extremely friendly conditions.

For those inclined to fret, one might worry about the sustainability of such easy conditions to the extent that they are unprecedented, and to recognize that future investment returns might have to be more muted than usual given the low starting point for rates and the high starting point for risk-asset valuations.

Room for growth

It is interesting to compare the current state of the U.S. economy to earlier recessions (see next chart). Undeniably, the amount of economic slack that opened up during the worst of the pandemic (also known as the output gap) was far greater than at any other time in modern memory. However, around 70% of that has since closed.

The economy is now closer to its potential than it was during the worst moments of the financial crisis – thank goodness – but it is still roughly in line with the economic troughs recorded during the recessions in the early 1990s and the early 2000s. It doesn’t feel that way to most people since governments and central banks have been much more proactive about providing financial support. But there is still a significant distance left to travel.

The good news is that economies are naturally buoyant. In fact, the greater the economic underperformance, the greater the subsequent buoyancy. As such, unshackled from social-distancing restrictions, we expect fairly fast growth over the next two years as the U.S. economy and others race their way back to normal from this starting point.

Still considerable room for catch-up growth in coming years

As of Q4 2020. Shaded area represents recession. Source: CBO, Macrobond, RBC GAM

Booming manufacturing

It is well understood that service-sector industries have been hit disproportionately hard by the pandemic. Many remain seriously depressed by government restrictions (see next chart).

However, manufacturers have suffered much less damage. While they did contract palpably in the spring, the damage was significantly less than that inflicted upon the service sector. And, remarkably, even as some areas of the service sector have been punished for a second time in recent months, a key global manufacturing leading indicator (The JP Morgan Manufacturing PMI) has actually just ascended to its highest reading in a remarkable 34 months. The sector is seemingly booming.

Global Services Purchasing Managers’ Index softened amid latest virus surge

As of Dec 2020. Source: J.P. Morgan, HIS Markit, Haver Analytics, RBC GAM

Our real-time economic indicator

Our U.S. real-time economic activity indicator continued to edge lower across January (see next chart), presumably because of tighter economic restrictions. We budget for a month or two of economic decline in the U.S. based on this signal. Within this, our real-time measure of hours worked by hourly workers has been declining slightly. However, it is notable that the consensus forecast for this Friday’s payrolls report is for the addition of a modest number of workers in January, in contrast to the loss recorded in December.

U.S. economic activity has shifted to low gear

As of 01/23/2021. Economic Activity Index is the average of 10 high-frequency economic data series measuring the year-over-year percentage change. Source: Bank of America, Goldman Sachs, OpenTable, Macrobond, RBC GAM

One undesirable development is that the New York Fed’s weekly economic index has stopped rising. It had been increasing even as our real-time activity index had begun to fall in November, but has now stumbled in January (see next chart). The index lacks several of the real-time indicators we rely upon, but is therefore less likely to be distorted by seasonal issues.

United States, Federal Reserve Bank of New York, Weekly Economic Index

For the week ended 01/23/2021. Source: Federal Reserve Bank of New York, Macrobond, RBC GAM

U.S. traditional indicators

As traditional economic indicators arrive and fill in some of the holes left by the real-time signals, we can comment more confidently about the recent economic trend. The U.S. economy managed to continue growing in the fourth quarter, rising by 4.0% annualized.

Weekly jobless claims then deteriorated somewhat across most of January, before staging a material improvement in the latest week. Numbers fell from 914K back to 847K (see next chart).

U.S. jobless claims have flat-lined

As of the week ending 01/23/2021. Shaded area represents recession. Source: DOL, Haver Analytics, RBC GAM

The ISM (Institute for Supply Management) Manufacturing Index has now been released for January. It reveals a modest decline from 60.7 to a still-good 58.7. However, particularly when paired with the Markit Manufacturing PMI and the Markit Services PMI that were released earlier, the main message is surely that the U.S. economy held together surprisingly well in January.

One interesting detail in the latest report is that the prices-paid component has surged to a reading of 82.1 (50 is neutral) – the highest level in years. It would appear that rising commodity prices are visible in manufacturer’s costs.

Canada surprisingly solid

Although some of Canada’s small and medium-sized businesses have been shuttered by recent restrictions (see next chart), a broader barometer from the same source – the Canadian Federation of Independent Businesses – argues that small and medium-sized businesses were feeling fairly good overall in January, and doing slightly better in January than December.

Indeed, the Canadian economy has recently reported some surprisingly good results:

• Canadian monthly GDP in November rose by 0.7% – roughly twice what had been expected.
• Monthly GDP for December has been tentatively pegged at 0.3% by Statistics Canada. This means that the economy grew by around 8% annualized in the fourth quarter.

That is twice the U.S. fourth-quarter growth rate, though we expect Canada to give some of this outperformance back in the first quarter of 2021.

Canadian businesses forced to shutter during second round of lockdown

As of 01/22/2021. Source: CFIB, RBC GAM

One hint of slippage may come from Canada’s January employment report, due later this week. The consensus forecast is for a 46K decline in employment. That is better than the 53K loss in December, but nevertheless a second decline.

A bit of U.K. Brexit damage

The latest U.K. Manufacturing PMI has now been released. It is consistent with a manufacturing sector that continues to grow despite great challenges to other facets of the British economy due to COVID-19. But one tidbit caught our eye: the report also flagged extremely long supplier lead times – in fact, the longest in the nearly 30-year history of the series, barring an extreme COVID-19 outlier in April of last year. While it is still extremely early going, it appears that the U.K.’s long-awaited exit from the European Union is – at least initially – impeding supply chains somewhat.

The balance of macro risks

It is important to consider the risks to one’s base-case forecast. When we engaged in this exercise a quarter ago, we thought that the risks tilted somewhat more downward than upward. Now, a quarter later, we believe the risk profile is somewhat more symmetrical.

One reason for this evolution is that some of the earlier downside risks have partially manifested. This means that today’s base-case forecast includes a portion of last quarter’s downside risk. For instance:

• We flagged the potential that COVID-19 would spread more readily than expected last quarter, and lo and behold there are now new, more contagious variants that will likely become the dominant global strain.
• Similarly, we flagged the risk that vaccine expectations were priced to perfection a quarter ago. Indeed there have been some stumbles since.

Nevertheless, from here, we see roughly balanced risks for the future (see next chart).

Key global macro risks over the next year

As of 01/29/2021. Size of each bar reflects probability-weighted impact of bull-case/bear-case scenario. Source: RBC GAM

To be sure, there remains a greater risk that vaccines will disappoint rather than exceed expectations. Similarly, there are real risks around future waves of COVID-19.

What balances these are net upside risks with regard to fiscal policy, namely:

• the prospect that governments would step in to ease the economy’s pain in the event of disappointing vaccines or infection numbers
• our belief that economies could snap back surprisingly quickly once the worst of the pandemic is over, and
• the real possibility that the Chinese economy continues to exceed expectations.

-With contributions from Vivien Lee and Sean Swift