S&P 500 Sets New All-Time High; Falling VIX = Risk-On
If you had any reservations about whether last week’s rally was sustainable, this week’s performance was decisive. On top of a 7% rally last week, the S&P 500 rose another 2.2% this week to 3,585; a new all-time high for the index. And I see several reasons that push the market and epicenter stocks in particular, higher into year end. More on this below.
COVID-19 is spreading across the US at an accelerating rate and as we commented earlier this week, the US could see >200,000 cases within a few weeks. The tally for Thursday was >148,000 (+34,000 vs 7D ago), so by Thanksgiving, daily cases should surpass 200,000.
And given flu season lasts until Feb 2021, a peak in cases is still sometime away. But the states we are watching most closely are those with fastest case growth in Wave 3, WI, IL, ID, ND, SD, UT, or WIINSU. With the exceptions of ND and SD, daily cases are still surging there. And while we are seeing soft lockdowns in New York and even Illinois, we have yet to see real panic by policymakers in these wave 3 states.
Interestingly, the hospitalization coefficient (or % of new cases requiring hospitalization) varies widely by state. Take North Dakota and Utah for example. These wave three states have a coefficient around 0.4%, which translates to about 1 in 250 confirmed COVID-19 cases resulting
Compare this with Connecticut and New Jersey. The coefficient In these wave 1 states is 2.7% and 3.1%, or 1 in 37 and 1 in 32, respectively. That is a massive differential. A COVID-19 confirmed case in CT/NJ, aka NY tristate, is basically 10X more likely required to be hospitalized. Wow.
Is this due to demographics (age), co-morbidities (obesity, smoker?), or just plain bad luck? We have no idea. But within the major wave 3 states, which I refer to as WIINSU states, they are dealing with less severe forms of COVID-19.
And looking at mortality rates (daily deaths), the severity of COVID-19 in wave 3 states is running below Waves 1 and 2. Wave 1 saw a massive level of carnage in the NY tristate area with 20 deaths per 1mm. Wave 2 saw the states of FL, CA, AZ, TX, or F-CAT see daily deaths of 7 per 1mm. Wave 3, so far, is running below that level of 7 deaths per 1mm residents seen in wave 2 for F-CAT states.
So, despite record cases in Wave 3, the daily deaths have trailed what we saw in Wave 1 and Wave 2. In other words, the level of mortality is far lower.
STRATEGY: Is 200,000 daily cases enough to stop the epicenter rally?
For the better part of the last few weeks, we have seen a fierce rally in epicenter stocks, and gasoline was added this week with the Pfizer vaccine news. But over the past few days, the epicenter rally has run into a brick wall. Did the surge in cases finally break the market’s tolerance? Was stimulus talk failure on Thursday throwing water on Washington getting something done? Is this just profit taking? I don’t know.
But I think the risk/reward is favorable for epicenter stocks into year-end, even as COVID-19 cases are rising. I see major developments that favor these stocks: (i) Development towards a vaccine are now outweighing the headwinds of rising COVID-19 cases, (ii) Europe COVID-19 cases are indeed rolling over (iii) Retail investors are finally moving cash off sidelines — they are going to become dip buyers, and (iv) the VIX, a measure of market’s anticipated volatility, looks ready to fall below 20.
The VIX, has not been below 20 since the start of the pandemic and in our view, a move below 20 would be a major risk-on signal, as it would suggest that investors see lower volatility in the coming months. This would be quite a change for much of 2020. And if so, investors would not only be more “risk-on” but we could see a risk on investment leverage as well. In other words, this would be more firepower to buy equities.
This week we also updated our Trifecta Epicenter stock list. These are the stocks which were hit the hardest by the pandemic and have the greatest operating leverage to a re-opening. And we like the earnings upside in these stocks, because of the massive cost reset. The stocks are based on positive views coming from the trifecta of: (i) Quant (tireless Ken), (ii) Global Portfolio Strategy (Brian Rauscher, aka Rocky) and (iii) Technicals (Rob Sluymer).
Bottom Line: I think the risk/reward is very favorable for epicenter stocks into year-end, even as COVID-19 cases are rising. A break below 20 in the VIX would be a major risk-on signal and would equate to more firepower to buy equities.
Figure Comparative matrix of risk/reward drivers in 2020
Per FSInsight
Figure: FSInsight Portfolio Strategy Summary – Relative to S&P 500
** Performance is calculated since strategy introduction, 1/10/2019
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