Vaccine News Causing Risk Premia Collapse = P/E Upside
Daily COVID-19 cases saw a surprising improvement Wednesday with daily cases coming in at 38,377 which is down -5,235 vs 7D ago. Typically, Wednesday cases see a big surge vs 1D ago (usually up +6k or so) but was flat. This is a break in pattern vs the prior 10 days where daily cases were flat vs 7D ago. I don’t want to jump the gun, but this positive surprise to the downside is a nice inflection. Perhaps the surge associated with back to school is being offset by the organic retreat in cases.
This week, there was no new outbreak in NY tristate nor Northeast, no new outbreak in 4 epicenter states, FL, CA, AZ, TX, or F-CAT, but continuing rise in cases from states with low case prevalence. The improvement we saw in cases this week is the largest in two weeks and at this pace we could see daily cases sub-30,000 next week, which would be a convincing improvement.
Stocks reacted strongly Wednesday to the CDC notifying states to prepare for a vaccine by November 1. As the Bloomberg story below notes, the CDC is asking states to remove obstacles to prepare for widespread distribution on that date. If a bona-fide vaccine is available November 1, this is a big deal. The US Project “Warp speed” targeted the availability of a vaccine by early 2021, and one rolling out November 1 is “way ahead” of schedule. The US survived a stress test not seen in 5 lifetimes, not really since the medieval plagues, and equities similarly survived.
Any US company surviving this “stress test” will see forward equity risk premia fall, which would translate into higher P/E, and hence, would see significant upside.
Strategy: The US Project “Warp speed” is targeting the availability of a vaccine by early 2021, and there may be a vaccine delivered earlier than that. If a vaccine arrives in the coming months, expect surviving companies to see falling equity risk premia and higher P/E.
A proxy for equity risk is the delta between earnings yield (inverse of P/E) and bond yield (IG corporates) and as shown below, since 2009, this risk premia has been 1.61%.
– Current equity risk premia is ~1.61% or right on top of where it has been since 2009, stocks not expensive. But if we look pre-2009, risk premia is actually negative -1.48%
We can calculate the implied equity P/E if equity risk premia moves back to pre-2009 levels. We think this is warranted given these companies survived and many prospered during the greatest stress test of our lifetimes.
I f risk premia moves to pre-1996 average, implied equity P/E would be 192X EPS. We do not seriously expect the S&P 500 P/E to move to 192X anytime soon. But you get the idea. Stocks can be dramatically re-rated higher. Thus, we would be long equities here.
Money on the sidelines has “barely” budged and is now down to “only” $4.5 trillion from a peak of $4.75 trillion. Clearly, investors remain cautious and there is more cash on the sidelines than the February 2020 highs when it was $2.8 trillion, a difference of $1.7 trillion. Is it any wonder stocks still have massive upside?
Bottom Line: There is a pathway for a vaccine in the foreseeable future, which would reward surviving companies with a lower equity risk premia and increase P/E.
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
* Portfolio strategy introduced in December ’19 rebalance, replacing 2019 portfolio recommendation – “FANG in odd years”
More from the author
Articles Read 1/2
🎁 Unlock 1 extra article by joining our Community!
Stay up to date with the latest articles. You’ll even get special recommendations weekly.
Already have an account? Sign In 829eb8-a25d64-e66dfd-baea81-85cff5
Already have an account? Sign In 829eb8-a25d64-e66dfd-baea81-85cff5
