Despite COVID-19 Uncertainty, Don’t See Retest of Market Low

The most obvious reality regarding the coronavirus (COVID-19) outbreak is that nearly everyone would agree there is much uncertainty. There is no playbook for a pandemic. And 10-, 20- and even 50-yr datasets are not so useful, because they encompass exactly zero similar episodes. The two biggest uncertainties are 1) the path of the healthcare crisis: When will it end? When is the vaccine/cure coming and will there be a second wave in the Fall? 2) Will consumers ever return to a restaurant, movie or concert? How much damage has been wrought? What is the new normal?

Nevertheless, there are five things (+a bonus) that are “certain”: This isn’t a normal business cycle; federal policymakers have acted with lightning speed; the bond market is functioning well; consumers are emerging from their bunkers, though the speed is unknown; and we are certain everyone is “uncertain,” right? Bonus: the Standard & Poor’s 500 index (SPX) has retraced 50% of its losses, and since 1929 in the 10 declines >30%, a 50% retrace has eliminated a retest of the low.

These certainties are important, as they can anchor a framework to understanding the crisis. One cannot really have an investment view without having a sense for where we are in the healthcare crisis. At the same time, as the economies re-open, we need to calibrate our “certainties” against these incoming data points.

POINT #1: Recent NY state figures have shown steady improvement. In phase one, the state is set to open five regions on 5/15, pretty comprehensive, including construction, agriculture, retail, manufacturing and wholesale trade. That’s in contrast to CA, which is also easing restrictions in phases, but counties have taken their own interpretation of these guidelines. Hence, the Alameda dispute with Tesla (TSLA). And LA county extending its stay-at-home orders.

POINT #2: Five countries in Europe have been open for at least three weeks. No signs of “second wave.” Moreover, based on the data gathered by our data science team, led by tireless Ken, 14 countries (representing 66% of Europe’s GDP, $14.5T USD…) have eased stay-at-home restrictions and are in some state of re-opening. Since opening 30 days ago, Austria daily COVID-19 cases are down 82%, while in Germany, since opening 24 days ago, daily COVID-19 cases down 62%. In hard hit Italy, since opening 10 days ago, daily COVID- 19 cases down 47%

The takeaway is European nations are not seeing a second wave since opening. This should give some comfort about what the US experience might be in coming weeks.

POINT #3: Revisiting NYC COVID-19 Mortality. ~3X deadlier than flu (2017-18) and ~9X deadlier for 50-64-year olds (but 83% of these had “higher risk underlying condition.” The NYC fatality rate = 8.2% but greater than 25% for those older than 65. Adjusted for implied prevalence per serology, overall it is 0.73% and 2.23% >age 65.

Though the COVID-19 serology tests could be inaccurate, given the 4 sets of NY state tests, and very similar results, the results at least are consistent. Additionally, if there are type I (false positives) and type II (failed to detect) errors, given NYC has the highest official prevalence of any city, it still means the testing data generally is more accurate even with both types of errors. Second, the flu mortality data is from the CDC and is the US overall. The mortality rate of flu might vary by region, so NYC could have a different seasonal flu death rate.

We consider the possibility that COVID-19 NYC prevalence could be much higher than the official 2%, as NY governor Mario Cuomo has stated (>25%), and this naturally alters the case fatality rate (CFR). Adjusting the denominator, the CFR overall drops to 0.73% (still high) but way better than 8.2%. The adjusted figures basically show that many cases are mild and do not require hospitalizations. But that this does not reduce the human toll of this disease. As of mid-week, over 15,000 NYC residents succumbed to COVID-19.

On a total basis, for a 50-64-year-old, the overall risk of death is 0.45%. This is high and 9X higher than the flu. But if this adult has none of the above conditions, the risk of death is 0.07%, which is nearly identical to flu, 0.05%. With mitigation, like PPE, hand sanitizer, masks, etc., the overall risk is less scary. The key takeaway is again about how this impacts employees and customers as stay-at-home restrictions ease. The risk to an adult without the underlying condition, even older adults, is actually quite low.

Remember the dual epicenter –> NY tri-state area + nursing homes = 74% of all COVID-19 deaths. The rest of the U.S. is 26%, a shocking statistic. This is not to minimize the tragedy. But this means of the ~87,000 COVID-19 deaths in the USA. ~23,000 outside the 2 epicenters.

STRATEGY: I think stocks have upside because there is more certainty than consensus realizes, not because we think stocks are “cheap” on 2020 EPS. It is also perfectly rational for investors to expect profit taking and a sentiment reset. I just do not think a pullback warrants major tactical changes, partly because we do not find sentiment to be that constructive. Investors tell us that: there is zero visibility; good stocks are expensive on 2021 EPS; and it’s hard to know if things have bottomed, etc., etc.

But the best times to put fresh money into equities is when economic data is absolutely at the nadir (which a lot of data seems to suggest now). The April US ISM manufacturing index was 41 and likely to fall below 40 next month. If it rises, then the equity case for stocks is arguably stronger, because it shows the magnitude of the contraction is milder than implied by the labor reports (my view). In the last 70 years, the best time to invest in the SPX is when the PMIs are below 43. The opposite is true, too. When PMIs are strong, S&P 500 returns are poor.

The bottom line: I think the fact there is more certainty than most appreciate is a positive.

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