Using seven-day comparisons, there is now steady progress in coronavirus (COVID-19) cases in the U.S. each week. I still think we need to watch day-to-day changes and spot sustained dislocations, but the trend clearly shows US COVID-19 cases are slowing.
There is also progress on the re-opening front, with more and more signs of an America returning to normalcy. Texas Gov Greg Abbott announced professional sports will allow fans to attend with 25% capacity, a major step. Walt Disney’s (DIS) re-open plans suggest the “social distance” victim businesses are proving they are finding ways to adapt. Again, American businesses are survivors and adaptable.
The market rose about 3% this short trading week, with a pronounced strong relative performance by the “epicenter” groups (Discretionary, Financials, Industrials and Energy). For the most part, it appears the US is now past the bottom on the peak on COVID-19 cases, hospitalizations and deaths, on economic fundamentals, and on equities. If these three points are correct, then this is the time for “epicenter” (aka cyclicals) to lead.
POINT #1: While daily COVID-19 cases have surging ups and downs, if we look at 7-day changes in COVID-19 reported cases, we can see sustained improvements on a week over week basis, even as testing has surged. There is still a risk of a second wave, and while we have not seen evidence of this yet, this bears watching. Nevertheless, falling positivity is suggesting this is not the trend.
POINT #2: Growing body of research shows high levels of vitamin D reduce the COVID-19 severity. Among Vitamin D benefits is a boost to the immune system. Recent studies show severe cases of COVID-19, ICU or hospitalizations, tend to have Vitamin D deficiencies. Most people get sufficient Vitamin D from sunlight and from some foods, including oily fish, like salmon, mackerel, and herring.
It turns out that a surprising 42% of Americans have vitamin D deficiency. Note that Vitamin D deficient population cohorts are similar to those suffering from severe COVID-19 outcomes. A NYC COVID-19 study published about a month ago found the following: African American- 92.3 deaths per 100,000 population; Hispanic, 74.3; White, 45.2 and Asian, 34.5. CDC risk factors for COVID-19 show many factors overlap in a striking way with those same groups with low Vitamin D deficiency: chronic lung (smoking), diabetes/obesity, heart conditions, obesity, etc. If Vitamin D plays a “silent” role in COVID-19 severity, the summer months might help prevent a second wave.
POINT #3: A CNBC interview of Larry Kudlow, NEC Director for White House (link) shows still many policy levers available. On supply chains, Kudlow spoke about ways to incentivize and also facilitate a move back to the U.S. The other subject was incentives for hard hit businesses such as restaurants; tourism; and air travel, collectively travel and expenses (T&E). Total domestic and international air travelers spent $1.1 trillion in the US in 2019, 5.5% of US GDP, with US travel 86% of the total. Our past work suggests business related travel spend is 80% of the total.
Data from a Chase Treasury presentation made a few years ago shows that air travel, lodging and restaurants make up about 70%-75% of the total expense. Using this data, and some US Chamber of Commerce estimates, we can aggregate T&E spend. Middle markets ~50%. The math is crude and based on “guesses” for number of organizations in each category. So if you would like to play with data, our data scientist, tireless Ken, is happy to send this along. Also, neither small biz nor government spending is reflected here. Both are big spenders as well. Fortune 500, which is a good proxy for S&P 500 is estimated to spend about $25 billion annually.
STRATEGY: COVID-19 Depression is a gauntlet that a cyclical business could never really prepare for, but if it survives a 40% GDP drop, with equity not diluted, doesn’t this mean that business is a lot stronger than we realized? This happened with homebuilders in 2008, and banks after the financial crisis, by the way, with survivors improving their position and share prices.
The same is probably playing out today in “epicenter stocks:”: retailers, restaurants, airlines; hotels, casinos, industrials, banks, and energy. The “epicenter” stocks that survive this is another reason to have “less barbell.” If we are correct, this will result in these stocks surprising on both EPS and with higher multiples. Epicenter stocks are only 26% of the market cap of the S&P 500, but we believe could represent 62% of the points gains in the next few quarters (see our prior comments on this).
Naturally, comparative valuation matters so we plotted the following 2021 metrics for the growth, defensive and “epicenter” groups, based on bottoms-up consensus estimates. See table.
As you can see, the “epicenter” stocks (in red) are inexpensive on a P/S basis especially compared to 2.1X for S&P 500 overall. And yet, the 2021 sales growth is forecasted to be 1.5X or better. Again, because margins are depressed, I think it is penalizing these stocks to look at EPS. Moreover, we believe 2021 EPS will surprise to the upside because of cost savings.
Additionally, growth and defensives are becoming bond “proxies,” with a fairly high correlation to bonds. Whereas, “epicenter” stocks have none. I think the valuation expansion of FANG, growth, and defensives can be explained by falling rates.
The bottom line: The “epicenter” are reasonably priced and the risk/reward best there.
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
