By Rupert Thompson, Chief Investment Officer at Kingswood

Equity markets ended last year on a bullish note and this optimism has carried through to the start of the new year. Global equities gained 1.3% in local currency terms in the last week of 2020 and European and UK markets are up another 1.5-2% this morning.

Two events have help buoy sentiment over the last couple of weeks. First, the US finally agreed a fiscal stimulus package worth $900bn or 4% of GDP, despite Donald Trump’s best attempts to thwart it. Second, a Brexit deal was reached at the eleventh hour.

The market reaction to the Brexit news was as expected rather less euphoric than that of Boris Johnson. After all, a deal was maybe always the most likely outcome and is limited in scope. The pandemic is also a much bigger deal than Brexit at the moment. Still, the disruption posed by a No-Deal has been avoided and sterling has bounced a cent or two against the dollar. UK equities overall have also outperformed a little as have mid and small cap stocks.

As to the long term impact of Brexit on the UK economy, the hope is that the damage is significantly less than the 4% hit shown by the government’s official forecasts. This will hinge on how successful the UK is both in securing free trade deals with other countries and in its forthcoming negotiations with the EU over the financial sector.

Returning to markets, their prospects over the coming year really hinge on the virus, the vaccine and policy. Near term, there is no denying that the news on the virus is bad. Infections are spiralling out of control in the UK and there is the risk that other countries will face similar problems as this more contagious mutation spreads.

Markets, however, appear oblivious to this. Their hopes rest firmly on a rapid vaccine roll-out allowing a return towards normality from the second quarter onwards and a burst of strong growth on the back of this. While logistical issues shouldn’t be under-estimated, the Oxford-AstraZeneca vaccine (which is much easier to distribute than the Pfizer one and has this very day started to be used in the UK) makes such a time-line considerably more feasible.

Unless a rapid roll-out is seriously called into question, rather than just pushed out a few weeks, markets should continue to be supported even while the UK and European economies are contracting again.

This disconnect between Main Street and Wall Street (as they say in the USA) should be sustainable because of continued policy support. Fiscal stimulus is essential if the economic damage done is to be contained and should be forthcoming with the UK furlough scheme extended until end-April and a budget deal now agreed in the US.

Monetary policy is also key. This is not because any further easing will be particularly effective in propping up the economy. It is more that the prospect of rates remaining super low for the next few years will keep a lid on any rise in bond yields. This is critical if the current high valuation levels of equities are to continue to be justified.

The bottom line is that markets for the large part look likely to continue to focus on the relatively rosy scenario in prospect a few months down the road – rather than be dragged down by the increasingly grim news headlines, particularly here in the UK.  It is often said the darkest hour is just before the dawn.