After notching four consecutive days of gains, the S&P 500 took a well-deserved break and finished flat on Friday, leaving a massive 7.3% weekly rally intact. I consider this a huge win, especially in the face of a still undecided election outcome. Since the start of this rally at the end of October, we are now nearing the September 2020 highs around 3,580. And I see further upside into year end. More on this below.

As for COVID-19, the spread continues at an accelerating pace. This week, daily cases came in above 100,000 for the first time and they seem set to rise further.  The fastest spread remains in the wave three states, in particular, WI, IL, ID, ND, SD, UT, or WIINSU.

Stocks up 7.3% in Big Week; Potential for 10% Rally into YE

Within WIINSU, the most rapid spreads are in North Dakota and South Dakota. In these states, daily cases per one million residents are roughly four times the amplitude seen in wave one and wave two states. Wow. These states also have very low levels of testing (the positivity rate is >50%) and daily deaths per one million residents, while still below the peaks seen in New York City/Tristate region, have surpassed Italy in its darkest days.

Peeling back the onion another layer, I think county level data bears watching; especially in these states that are seeing massive outbreaks. Looking at the percentage of the state where daily cases are exceeding certain thresholds (e.g. 1,500 daily cases per one million residents – which is where Miami peaked), the situation in South Dakota could provide some insight into what signs of “herd immunity” look like. Cases are rising in SD and I have not found a single statewide policy action taken. And interestingly, the percentage of counties with daily cases exceeding 1,500 cases in South Dakota is declining, which could prove to be a data fluke or could be first signs of “herd immunity”. I think this bears watching.

STRATEGY: Was this rally justified, even with a contested election?

In our view, if one believes more than one of the following factors below, then the answer is yes.

  • (i) Stocks already discounted a contested election and fell 10% in the past month, (ii) Investors were cautiously positioned into election day (cash on sidelines >$4.5T), (iii) Tech rallied due to Republicans holding the Senate (tax cuts off table), (iv) Mutual fund/ year-end tax loss selling is over and seasonal weakness is ending, (v) Santa Claus rally still in play, (vi) Republicans holding the Senate makes fiscal stimulus prior to year-end more likely (vs lame duck), (vii) Republicans holding Senate maintains a balance of power which is good, (viii) many of our clients were bracing for a “limit down” Tuesday overnight futures session, so markets priced in a scary night, and (ix) the VIX collapse suggested the market saw more certainty in the election outcome compared to the official electoral college.

So, as you can see, there are multiple reasons that stocks were relieved. In fact, this goes back to a simpler observation: less uncertainty, is incremental certainty and this supports a risk on sentiment.

So, I think the rally in stocks makes sense and still see the potential for a 10% rally into year end, taking the S&P 500 to 3,600 while noting that a protracted legal battle that morphs into a street level chaos and violence could be a headwind.

Stocks up 7.3% in Big Week; Potential for 10% Rally into YE

We have written exhaustively about why the “epicenter stocks” (aka cyclical tilt) post-election day was the most logical (both under a Biden and a Trump win, and even contested). But consider the timeline shown to the right. Into year end, a rollover in Europe COVID-19 cases and fiscal stimulus create a favorable environment for epicenter stocks to lead. And looking forward to 2021, positive developments on the vaccine/therapeutics front and US COVID-19 wave 3 ending create a favorable environment for epicenter stocks.

Bottom Line: Based on several factors, the S&P 500’s strong rally this week seems justified, even with a contested election outcome. I see the potential for a 10% rally for stocks and still think epicenter stocks make the most sense.

Figure Comparative matrix of risk/reward drivers in 2020
Per FSInsight

Stocks up 7.3% in Big Week; Potential for 10% Rally into YE

Figure: FSInsight Portfolio Strategy Summary – Relative to S&P 500
** Performance is calculated since strategy introduction, 1/10/2019

Stocks up 7.3% in Big Week; Potential for 10% Rally into YE

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