NY COVID-19 Experience Should Be Template for U.S. Cases
Equity markets are weak to kick off the second quarter, as investors continue to struggle with the combination of U.S. coronavirus case growth and the concurrent weakening fundamentals of the economy. Although markets are down broadly, there is less of the “sell everything” panic feel in markets and even the VIX, while at 50, remains below the 80s seen a week ago. The upcoming 1Q EPS season could be a test of the market’s bottoming
The White House has spoken of 100,000 to 250,000 total U.S. deaths and a crisis peaking in 4-6 weeks from now, but the template to watch remains New York City and New York State, where the first real exponential breakout took place. The latest data shows that NYC “new cases” have been flat for five consecutive days, which could mean the market will bottom before the jobless claims peak. The next few days will bring COVID-19’s economic carnage (secondary front) into focus, with jobless claims, employment reports and the start of 1Q earnings reports.
POINT #1: A inconvenient fact–stocks bottom before jobless claims peak…. Talk of 9 million future jobless claims (it was 6.6 million April) is astounding because this represents about 6% of the employed workforce (152 million), and in just the last two weeks, 8% of the US workforce is now filing unemployment claims. Because of the economy’s sudden stop, this figure could double again to 16% (12 million more claims). However, this sudden stoppage of the economy is also suggesting that we could see a peak in jobless claims within the next few weeks, and possibly the 9 million could be the high-water mark.
– Stocks historically bottom 2-4 weeks BEFORE jobless claims peak. For example, during the 2001-03 bear market, the S&P 500 index bottomed on 3/11/2003, ahead of the jobless claims peak on 4/18/2003. Similarly, in 2009, the S&P 500 bottomed on 3/9/2009 and initial jobless claims peaked on 3/27/2009.
This sounds counterintuitive. Shouldn’t stocks bottom when economy is actually growing again? But we believe this reflects the fact that stocks respond to the “delta” in trajectory. Jobless claims lead employment. Thus, when jobless claims peak, it is only a matter of time before the economy starts growing again.
We are not experiencing a normal business cycle. We are actually facing a global economic shutdown, mandated by governments to deal with a pandemic. The traditional cycle rules are not in place, meaning it could be that jobless claims are not what matter. Maybe it will be some other derivative measure. However, stocks will bottom well before the economy bottoms, and well before employment recovers. We just cannot guarantee that jobless claims are the metric.
POINT #2: New York City and New York State are showing linear case growth, which is “less bad” and arguably good news. See chart below, which NYC cases have flat for the last 5 days and arguably flat for the last 10 days ranging from 2,700 to 4,000 new cases per day.
– Given the base of 45,707 cases, the daily increase has slowed to 8.6%, or a doubling rate of every 8 days. Just last week, case growth was leading to a doubling every 5 days. This shift to linear gains (daily case growth constant) also suggests that NYC could be closer to a peak than expected.
POINT #3: The key GDP states of the U.S. are essentially NY, CA, TX and MA. But NY remains the most important state, foremost because the first exponential eruption was NYC (40% of total US cases). Moreover, those four states produce a large share of US GDP. CA is linear (hopefully does not revert to exponential), and MA is worsening but has strict measures in place. Texas just saw a doubling of new cases to 731 compared to 389 the prior day. It bears watching. But if NY has turned, we believe markets will have a template to model the US healthcare peak.
As I noted recently, the upcoming 1Q EPS season could be a test of the market’s bottoming. We estimate the SPX monthly EPS run rate has fallen from around $13/month to as little as $4/month because of the massive stoppages, a kind of heart attack for the economy. However, it does not make sense to apply a 15 times P/E multiple to that temporarily lower base. A 15X P/E means investors are paying for 15 years of earnings. The sum of the next 60 quarters for S&P 500 EPS (7% CAGR) is $4,890. Thus, at around 2,500, the S&P 500 is valued at exactly half the value of EPS for the next 15 years. That seems extreme.
Lastly, a few weeks ago there was a widely circulated Imperial College study that said the U.S. could see deaths of 2-6 million. This is the reason the White House dramatically shifted strategies and basically shutdown the whole economy. It turns out the authors of the original study now revised down the estimate of deaths by 96%. (https://www.imperial.ac.uk/news/196496/coronavirus-pandemic-could-have-caused-40/). This changes things: Downside scenarios are getting reduced odds or eliminated.
What could go wrong? Data could change with change with a super spreader, given the incubation periods.
BOTTOM LINE: There are “glimmers of hope.”
Figure: Comparative matrix of risk/reward drivers in 2020
Per FS Insight
Figure: FS Insight Portfolio Strategy Summary – Relative to S&P 500
** Performance is calculated since strategy introduction, 1/10/2019
