COVID-19 remains a global crisis and we realize that many people need to keep up with COVID-19 developments, particularly since we are moving into the more critical stage (“restart economy”), so feel free to share our commentary to anyone who has interest.
There were two notable positive developments in this COVID-19 crisis today. First, is the Moderna announcement of the initial success of its mRNA trial, with the first 8 recipients of the vaccine showing high levels of antibodies, enough to prevent cell infection and second, the surprise easing of restrictions by California, fairly broad including many retailers, churches and including sports by June 1 (NY Gov Cuomo also encouraged sports teams to consider opening in NY). Whether states have sufficient health metrics to justify re-opening is becoming secondary to the desire of citizens to emerge from their shelters (and nobody wants the goalposts moved).
According to the WHO, there are 8 vaccines in clinical evaluation today (including Moderna) and 110 in preclinical evaluation. This is 118 shots at creating a vaccine. That is a lot of research and momentum and really raises the prospects of a vaccine arriving sooner than the “12-18 months” guidance given by many health experts. This is positive.
But we continue to see this as “not a normal” business cycle. The best evidence, as we wrote yesterday, is the complete functioning of the credit markets (issuance and flows) while economic data is at depression levels. But if this is not a normal cycle, but instead, a global shutdown mandated by policy, we do not believe investors should try to link economic levels to financial market levels — i.e., PMIs are low, so S&P 500 should be flat on its back. The reason is that equities are discounting not just the next 2 quarters, but the present value of earnings.
Speaking of earnings, we are formally cutting our 2020 EPS to $50, from $110 previously (Street is $125) and keeping 2021 at $193. We explain our rationale below in detail (Point #3) but we have two drivers for this:
– First, 1Q2020 EPS shows March monthly EPS fell 60% to $5.50 from $13-$14/monthly level seen for most of 2019 and early 2020. And this is only 2 weeks of COVID-19 in 1Q2020. There will be 12 weeks in 2Q2020.
– Second, there are 3 drivers to COVID-19 EPS effects, (i) COVID-19 hit; (ii) expense reduction leverage and (iii) re-open lift/stimulus/rates.
The two latter effects do not kick in until late 2020. So, the middle months of 2020 are going to be bad and 2Q2020 should be a loss. We have a fuller discussion below, but this summary table shows the effects.
Source: Fundstrat
But this does not mean stocks should go down. On 2021 EPS of $193, the S&P 500 is trading at 15X that EPS figure. And we think that EPS number actually has upside (see commentary below). I think the S&P 500 is a pretty good risk/reward at 15X 2021, with record cash balances on the sidelines. And a vaccine that could come way sooner.
The S&P 500 today resolved the battle of the 50% (2,793) and 62% (2,934) retrace, breaking above this range and closing at 2,954. See below. This is potentially an upside breakout of this range and sets the stage for a move to 3,100 and above. In other words, the probabilities of a new low are diminishing. And given the record cash on sidelines ($4.8T, or 16% of market cap), we see favorable risk/reward.
Source: Fundstrat, Bloomberg
POINT #1: USA daily new cases 21,301, +1,257 from Sunday, but within the normal range. Lots of churn as 6 states jump, 7 states big drops.
Sundays and Mondays tend to see lower cases reported versus midweek (Nate Silver first mentioned this) and because some states like Kansas only report results in 3 of the 7 days, figures can move quite a bit. But the case numbers for today are essentially flat with yesterday. For today, there is a lot of churn. 6 states see fairly sizable jumps and 7 see big drops, and this net effect is +1,257 cases.
Source: COVID-19 Tracking Project
The 6 states reporting a rise is below:
– Illinois 2,294 vs 1,734 (1D ago) +560
– Tennessee 623 vs 100 +523
– New Jersey 1,705 vs 1,245 +460
– Kansas 454 vs 0 +454 (M/W/F report)
– Kentucky 247 vs 0 +247 (no Sundays)
– Pennsylvania 822 vs 623 +199
Total 6 states RISE +2,443
These 7 states reported sizable declines:
– New York 1,250 vs 1,889 (1D ago) -639
– California 1,591 vs 2,046 -455
– Wisconsin 144 vs 356 -212
– Washington 145 vs 337 -192
– Nevada 49 vs 195 -146 <–below 100
– Arkansas 54 vs 181 -127 <–below 100
– Rhode Island 121 vs 240 -119
Total 7 states DECLINE -1,890
The results for Nevada and Arkansas stand out because these figures are below 100 (daily cases), a nice milestone to see. Of course, there is jumpiness to the figures, so we cannot see this as the new level, yet.
Source: COVID-19 Tracking Project
California Gov Gavin Newsom announces a pretty abrupt reversal with the relaxation of restrictions to allow counties to move more quickly, including sports by early June…
CA Gov Gavin Newsom announced some pretty dramatic relaxation of the quarantine restrictions, including allowing retail businesses to open up for curbside service. This is a pretty abrupt reversal from last week and during the press briefing, even discussed opening up churches and hair salons sooner. What is behind this reversal is not entirely clear, and the counties still make their own decisions. But it does reflect the broader fatigue of residents regarding these stay at home restrictions. And perhaps the feeling the “goalposts” keep moving.
https://abcnews.go.com/Health/wireStory/california-relaxes-county-criteria-reopening-70752469
Even Massachusetts looks like it is moving towards allowing some businesses to open…
MA Gov Charlie Baker also announced plans to open the state’s economy. Essential businesses stay open, but now churches and houses of worship got the green light. And by Memorial Day (next week), hairstylist, pet groomers, some retailers will be allowed to open with curbside service. Restaurants (dine-in) are still restricted.
https://www.gloucestertimes.com/coronavirus/update-baker-allows-some-businesses-to-restart-with-limits/article_3804614c-995e-11ea-9c12-a7f846a0cda2.html
Total tests hovering around 350,000-400,000 per day
Total tests administered have reached a new higher level. And this is a good thing because testing alleviates concerns about hidden cases and spread. And the level of testing in the US is intense. At this level, about 3 million tests are conducted per week and 150 million per year. The entire US can be tested within this year.
Source: COVID-19 Tracking Project
POINT #2: Moderna Vaccine Trial shows promise, moving to accelerate Phase 2. Vaccine pipeline = huge. 8 in clinical evaluation. 110 pre-clinical. 118 shots at a vaccine
Moderna announces success in its initial vaccine trial and with FDA go-ahead to move to Phase 2…
Moderna, a Cambridge, MA-based biotech company, announced preliminary findings of its vaccine trial, with the first eight people who each received two doses of the experimental vaccine, showing all eight developed neutralizing antibodies to the virus at levels reaching or exceeding the levels seen in people who naturally recovered from COVID-19. And their study showed it prevented the virus from infecting cells.
Wow. This is obviously a promising announcement.
In fact, the results were promising enough, the FDA (Food and Drug Administration) gave Moderna the go-ahead this month for the second phase involving 600 people to begin soon. And if all goes well, a third phase to begin in July involving thousands of healthy people.
We are not really that familiar with the differences to each potential vaccine, but according to Moderna, the potential strength of Moderna’s mRNA approach to vaccine making is that it uses a genetic framework that can be quickly adapted for each new viral threat. More info is here from the company’s website: https://www.modernatx.com/modernas-work-potential-vaccine-against-covid-19
Moderna’s announcement accelerates the timetable for a potential vaccine… ending terror for most people.
The announcement, and the go-ahead from the FDA, show how the entire global healthcare system and regulators have mobilized to move quickly. A potential vaccine was seen as far as 12-18 months away and some skeptics even doubted a vaccine would ever be developed.
We don’t know if a vaccine is needed to re-open the global economy, but we know many people are hesitant to emerge from their ‘bunkers of safety’ unless there is a vaccine. So one can easily see why the financial markets move so explosively on this news.
WHO is tracking 8 vaccines in clinical evaluation + 110 vaccine candidates in the pre-clinical evaluation… MASSIVE pipeline.
The WHO has a draft document which lists the 8 vaccines in clinical evaluation (including Moderna/NIAID mRNA) as well as 7 other candidates. There are another 110 candidates in preclinical evaluation.
– this is a huge pipeline. 118 shots at a vaccine.
Source: https://www.who.int/who-documents-detail/draft-landscape-of-covid-19-candidate-vaccines
The 8 candidates are shown here and the 110 in the pre-clinical evaluation are in the document, but we did not include for practical reasons.
Source: https://www.who.int/who-documents-detail/draft-landscape-of-covid-19-candidate-vaccines
POINT #3: Revising S&P 2020 EPS forecast to $50.00 (vs $110 previously and Street at $125.00), keeping 2021 at $193.00
1Q2020 EPS came in at $33.49 per share, down 14.5% from a year ago (1Q2019). But 1Q2020 only reflected less than 1 full month of the COVID-19 stay at home impact (2 weeks really). And as the table below shows, this put the actual March monthly EPS likely down 60% YoY (assuming Jan and Feb were fine).
2019 Monthly EPS averaged ~$14.00 per month for each of the months in 2019… implies March 2020 EPS was $5.50
We can estimate monthly EPS by taking quarterly EPS and dividing by 3. This may seem simplistic because of seasonality (retail, etc.) and FX impacts, etc., but monthly EPS in 2019 was surprisingly uniform.
– it was roughly ~$13/month in the 1H2019 and rose to ~$14/month in 2H19. Consistent.
– let’s assume this monthly run-rate continued into 2020, thus, Jan and Feb 2020 monthly EPS was ~$14.00.
1Q2020 should have come in at $42.00 or so (which was the original consensus). Actual 1Q2020 came in $9 lower, presumably because of two weeks of impact from COVID-19 (mid-March to month-end).
– If Jan + Feb were $14.00 each, this is $28.00
– implies March EPS was $5.50 (see below)
– March EPS is down 60% from the monthly run-rate and that is with only 2 weeks of shutdown.
Source: Thomson Eikon and Fundstrat
The shutdown impact will be even more severe in 2Q2020, because instead of 2 weeks, it will be 12 weeks worth of COVID-19…
In late March, we posted this sensitivity table to estimate the revised monthly EPS for the S&P 500. The two levers we use are: (i) top-line decline (for each of the 10 sectors) and (ii) cash cost avoidance (% of revs).
– In the June quarter, companies have the worst of two worlds
– top-line hit is immediate given the stay-at-home orders and the shutdown of global trade, the collapse of PMIs, etc.
– expense avoidance is largely non-existent, as companies cannot adapt quickly enough.
2Q2020 EPS likely -$12.50, use the following assumptions to estimate 2Q2020 monthly EPS is -$9.00/month to +$3.50/month…
Using this sensitivity table, we estimates 2Q2020 monthly EPS is -$9.00/month to +$3.50:
– Topline is down -24% to -28% YoY, Street is down 11% (too optimistic)
– Cash cost avoidance is a generous 40%-50% of revs
– This latter point is optimistic, arguably as this means companies can cut $0.40-$0.50 of expense for each $1.00 revs hit.
The range of EPS outcomes is the intersect highlighted below. And for the quarter, this implies 2Q2020 EPS of -$12.50, which is worse than implied by the March monthly EPS. This makes sense. Because the effect of disruption is greater in 2Q2020. And don’t forget, companies are not providing guidance.
Source: Fundstrat
As we move through the “valley” EPS should ramp up strongly in 3Q2020, 4Q2020 and really surprise to upside in 2021.
Three factors are weighing in on EPS over the next 12-15 quarters. This is:
– the impact from the economic shutdown (Corona hit) and this is worst in 2Q2020, and starts to fade
– the tailwind from cost engineering, which starts to be seen in 3Q2020 but really is strongest in 2021
– economic recovery tailwinds, which is both the re-opening + fiscal stimulus + interest rate savings. This should be the strongest in 2021.
Source: Fundstrat
2021 EPS could be $193 or even higher…
And this is why we see monthly EPS really strengthening throughout the remainder of 2020 and into 2021. And we think S&P 500 2021 EPS could be ~$193/share, which reflects the operating leverage from cost savings (engineering costs + real estate) and lower debt service due to lower interest rates.
Source: Fundstrat
Recall, in the GFC, 5 of 11 S&P 500 Sectors re-attained ALL-TIME HIGH (ATH) EBIT with lower revs…
The S&P 500 has a history of proving there is a lot of operating leverage. During the GFC, 5 of the 11 sectors re-attained ATH EBIT with less revs, including Consumer Discretionary with 13% less sales. (see below).
Source: Bloomberg and Fundstrat
Employee expense is 21% of cash expenses and real estate is expense #2… lots of ways to create operating leverage in 2020…
The composition of cash expenses attributable to employees is shown below. We estimate the employee expense is 21% of the $9.6T of total S&P 500 cash expenses.
– it is ~30% for Discretionary and Technology.
Hence, we see these two sectors as potentially posting the strongest operating leverage/cost engineering opportunities in 2020-2021.
Source: Fundstrat
