One of the top market rules for me, maybe even “rule #1,” is never to try to impose my views on the markets. And perhaps, it is more useful to try to decipher the message from market behavior. If I had to describe equities over the past week, they seemed to have been treating fiscal stimulus as a binary event. Regardless of the fact that this seems more of a “when not if” question to me. More on this below.
On the COVID-19 front, the trend in daily cases continued rising this week. This has been the case for the past few weeks and I see two major takeaways: (i) US cases could reach 70,000 within 2 weeks, matching the July highs, (ii) Because the spread is primarily in 11 states, we might be nearing peak velocity in those states.
We are still in wave 3 of COVID-19 in the US. And this wave, so far, is primarily a spread of cases in states that were largely unscathed in wave 1 (NY tristate +MA +RI) and wave 2 (FL, CA, AZ, TX, or F-CAT along with 19 tag along states). And this means COVID-19 is finding its way into areas of the US which are “caught off guard.”
So, part of the key over the next few weeks is for policymakers and citizens in these 20-ish states to “panic enough” to reduce the spread. There must be some of this taking place already, as daily cases are increasing but not soaring exponentially. And even states like South Dakota and North Dakota might already have reached peak velocity.
I think hospitalizations are increasingly a better measure for tracking COVID-19 spread and severity. I see several reasons for this: (i) expanded testing is leading to more detected cases, but not necessarily meaning rising infection, (ii) wide scale testing at schools, offices, certain businesses, means we will see greater detection (iii) there are many people who are testing PCR positive but are recovered.
In fact, the testing positivity rate in the US is 6.2% right now, well below 9% of wave 2. (see chart nearby). And in wave 1 and wave 2 states, positivity rates are very low.
So, on balance, I am feeling a bit better about COVID-19 this week, despite the fact that cases and we could reach 70,000 within a few weeks.
STRATEGY: Markets implying fiscal deal a “binary event” but it is “when not if”
For the millions of Americans with stimulus benefits expiring, the next coronavirus relief package is truly critical. Those who need this next installment of payments are those who are relying on the US for the safety net.
However, I see less at stake for equities. In other words, it does entirely make sense to me that stocks were stuck in neutral and seem to pivot on fiscal stimulus updates. But I revert to the rule #1, I can’t tell markets what to do. And despite the fact that a stimulus deal did not happen this week, it will happen before year end.
This week JPMorgan’s Fixed Income team made a very interesting comment. Their strategists suggest that US High-yield defaults have peaked for this cycle. This is a significant statement. High-yield is a close cousin of equities. And this economic depression has led to a surge in defaults in High-yield. But now, it looks like this cycle has peaked and if this is indeed the case, this is a major risk-on signal. Especially with 3Q20 earnings signaling that the EPS nadir is passed.
Bottom Line: Given the fairly robust incoming economic data, high levels of cash on the sidelines, and high anxiety into elections, this surely seems to be a set-up for a pretty big post-election rally. The more we churn here, the more impressive the post-election surge.
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
