As we finish the second week in February, the developments in COVID-19 have been largely positive. Notably, yesterday the White House signed the purchase agreement to secure an additional 200 million doses of COVID-19, bringing the total to 600 million by July (enough for 200 million Americans). 1.5 million vaccines were given this week vs. 1.2 million last week. There has been nearly a 20% drop in the positivity rate compared to seven days ago. Yet there seems to be a persistently negative public perception compared to many of these positive developments.

We have been monitoring organic case trends which have been very positive, despite the surge in more virulent mutations. Even in the nations where these strains originated, cases seem to be significantly collapsing. So, we are definitely experiencing a sustained organic trend in the right direction. At this rate, we could very well see less than 50,000 new cases a day by the end of February and half that by the middle of March. We’ve now seen 31 consecutive days of case decline.

Markets Seem Poised For ‘Risk-On’ as Data Improves

Many of you have been familiar with the work of IHME, which we have regularly highlighted as one of our favorite sources of data and forecasts on the path of COVID-19. Unfortunately, due to new variants and a forecasted decline in mask compliance, the organization is forecasting a 4th wave in March and April. Hopefully, this does not occur but this is incorporated into our base case. It stands to reason, if vaccination progress continues at the pace that it is, that markets may react less adversely to this potential uptick than past ones. This is since valuations are mostly comprised of future earnings that by the day have less and less chance of being affected by COVID-19 for wide stretches of the future.

Of course, the virus is exceedingly mysterious, and we do not take the risks of the new strains lightly. Our close monitoring of the vaccine technologies encourages us that existing platforms will be able to respond quickly, as Dr. Fauci has also indicated. So, for now despite risks we acknowledge we think it’s highly likely that stocks are now primed for a more ‘risk-on’ speed. There are signs all around the economy pointing to a coming boom fueled by pent-up demand and post-pandemic celebration.

As we noted last week, the extraordinary hedge-fund de-grossing that occurred along with the positive fundamentals we’ve been discussing led us to change our base-case which predicted a Q1/Q2 mid-bull market correction of 10%.

We have seen volatility continue to collapse this week, despite very choppy action and 3/5 down-days. This is another positive divergence that we wanted to highlight that we think indicates markets are getting ready to rally. The VIX sank to its’ recent low Friday despite the churn in equity markets. This suggest to us that fear is receding from the market.

As our clients are aware, we have been carefully watching the VIX and we view a decisive move below 20 as significant for two reasons. Firstly, a fall below 2020 takes the ‘Fear Index’ to pre-COVID-19 levels which would be a welcome ‘risk-on’ development. The second reason we know this to be significant is because systematic and quantitative equity strategies that drive the majority of institutional capital often allow increased leverage into the market as volatility drops below this key level.

Markets Seem Poised For ‘Risk-On’ as Data Improves

Well, on Friday the VIX collapsed nearly 6% and settled right above 20 but broke down to an intra-day low of 19.96. We see this as confirming our base case that volatility will collapse in 2021 and the stocks that provide the best risk/reward are the Epicenter stocks. Accordingly, with our change in base case we reiterate that we believe ‘Epicenter’ stocks will lead the indexes to significant new highs. Be sure to check out updated Epicenter Trifecta Stock list.

This further constructive action in the VIX makes us think markets will shift to ‘risk-on’ sentiment next week. We want you to consider some of the main macro events on the timeline in 2021. COVID-19 receding, Global GDP acceleration, prodigious fiscal relief, dovish Fed, greater interest in stocks, baby boomers shifting allocations from bonds to stocks, and interest rate increases should all result in equity risk premia collapsing (P/E rising). Wait, P/E’s going up when interest rates rise? It may seem counterintuitive but check out this analysis we did against different rate environments, inflation environments and Fed leadership. If the US 10Y is below 5% and rates are rising P/E will rise.

Markets Seem Poised For ‘Risk-On’ as Data Improves

Bottom Line: Our Base Case is no longer predicting a Q1/Q2 correction. Healthcare data and economic fundamentals are pointing to a strong recovery. Epicenter will have high EPS.

Per FSInsight

Markets Seem Poised For ‘Risk-On’ as Data Improves

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

Markets Seem Poised For ‘Risk-On’ as Data Improves

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