Much of US Population Could Approach ‘Infection Break Point’

As we close out the week, the best development is the recent sustained downturn in cases seen in the US (11 consecutive days cases down vs 7 days ago), and equally true of the current epicenter of FL, CA, AZ and TX (F-CAT). More on this below.

Markets were understandably unnerved by this tweet from President Donald Trump suggesting a “delay of the 2020 elections.” For obvious reasons, this defies logic. Indeed, that helped make our webinar yesterday more timely (thank you to clients who tuned in), as our head of Policy Strategy Tom Block offered several useful insights, including a chance for a Democratic sweep and control of White House, Senate and House.

Many might suggest a Democratic sweep is negative for markets, but I can see how it could be positive. Tom Block noted the likely top agenda items post a Democratic sweep are: corporate tax rates hike; modification of healthcare programs, and eased restrictions on immigration. The latter two are market friendly, in my view, because reducing the healthcare burden clearly eases a strain on the American consumer. And many studies show the benefit of immigrants on innovation and capital formation.

However, it might surprise investors that higher corporate taxes often lead to a capital spending rise. It’s rational. If taxes rise, companies seek to find tax shields. The most obvious one is depreciation and interest expense. History shows that the higher the marginal tax rate, the greater the cash flow benefit of capex and debt. Interestingly, in periods where corporate tax rates fell, capex (as % of GDP) also fell. If a Democratic sweep happens, we could see capex spending rise and cyclical outperformance.

STRATEGY: On Thursday, the US reported 2Q GDP, the worst ever contraction ever in its history at a 34.5% annualized decline. But investor sentiment already reflects this, and cash balances show high levels of skepticism. In the meantime, stocks historically bottom before the economy bottoms (which has happened). Granted, this GDP number was widely expected, so the equity market reaction was muted. (For more see page 1.) But isn’t this also the most unimaginably bad headline one could imagine?

A week does not a trend make, but have you noticed the considerably better performance of cyclical stocks this week? It has coincided with the plateauing of US COVID-19 cases. If the June-July surge is over, investors will eventually see the roadmap for the re-opening thesis.

Based on our conversations, investors simply do not want to take the plunge and rotate into cyclical stocks. Investors are favoring momentum stocks. This is logical if the COVID-19 virus is spreading at a faster rate. But we expect this to shift when investors are convinced the disease is receding. At some point, there will be enough evidence to see a downturn in COVID-19 cases. And that’s when I expect a rotation.

Overweight Granny shots – a good combination of core/ epicenter/ thematic ideas…. This group is a good combination of i) core secular growth names; ii) epicenter stocks and iii) stocks that benefit from longer-term thematic tailwinds. YTD, our Granny Shots strategy has outperformed the S&P 500 index by more than 2,000 bps, and in each month this year, except for trailing 120 bps in March.

POINT 1: Total USA COVID-19 cases came in at 69,071 Thursday, up 5,444 vs 1 day ago and a pretty typical mid-week pattern. But the key is that this is 1,839 lower than 7 days ago. We are now 11 days in a row where US daily cases are lower/flat vs 7D ago. To me, this is clearly a break in trend. A decline vs 7D ago essentially suggests the virus path is weakening. Daily deaths are creeping up, but this is a predictable lag to the surge in cases, but the daily deaths rate has not matched the pace seen in March/April, despite many higher numbers of reported daily cases.

Source: FSInsight, Bloomberg, FactsetPOINT 2: One of more impressive outcomes has been the large declines in cases seen in the NY tristate area, along with MA and RI. One of the reasons these states have not necessarily seen a resurgence is that their overall case prevalence was high, at greater than about 12,500 per 1mm residents. FL and AZ are well above this and TX is crossing this level. CA is just nearing this. At 12,500 cases per 1mm residents, it is a case prevalence of 1.25% and using serology estimates this implies >12.5% of the population is infected (10X). NY and NJ are considerably higher at 2.0%, or 20% as a proxy, and these states are probably closer to true herd immunity.

Our data science team, led by tireless Ken, found about 65% of the US overall has a case prevalence >12,500, suggesting nearly two-thirds of the USA has sufficiently high levels of case prevalence. I believe states with high case prevalence have also depleted a large pool of vulnerable population and therefore less likely to see massive spread.

The US may reach the overall “infection break point” with another 515,000 cases. There are 29 states with case prevalence <12,500, or 35% of the US population. An additional 516,552 cases would push these 29 states to 12,500, and at the current pace we could see this level reached in the next 30 days or so. This is simply an exercise. COVID-19 is unpredictable, but it is interesting to think about the potential depletion of the vulnerable population.

POINT 3: The latest McKinsey survey shows the gloom among US corporate is rising, which is not entirely surprising given the June-July surge in COVID-19 cases. However, one of the key issues remains liability management as the economy re-opens. This is one of the negotiating points in the Republican version of the CARES Act bill (limit liability). There are press reports that, workers are already starting to file lawsuits. Ultimately, this raises the importance and the binary nature of a vaccine and/or a cure.

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