Half-Full, Versus Half Empty

Since closing at an all-time high of 4,480 four days ago, the S&P 500 has been lurching violently lower.  Based on our multiple conversations over the past week, it seems the wall of worry had grown to a level that was beyond the investor’s appetite for risk. Stocks have been internally weakening for some time, so the sell-off on Thursday morning was a continuation of the internal turmoil within markets.

…But panic showed up in volatility markets, which if it reverses, is a sign that “bad news” is baked inAs Tom DeMark likes to say, “markets bottom on bad news, not good,” meaning stocks bottom when sellers are done selling.  And when there are no sellers left, stocks begin to rise.

Selling is not the only way investors seek to reduce risk, they can also buy volatility — that is, investors can neutralize positions by betting on a near-term rise in risk.  Thus, one way to identify “sellers are done selling” is:

– when spot VIX surpasses VIX futures with a future settlement
– compare, for instance, VIX spot level vs VIX futures 4M forward

Look below, you can see within the session this am, the spot VIX (dark blue) surpassed 4M VIX (red line).  

– it was a “touch” because at the close, VIX spot settled below VIX 4M futures
– this same “touch” took place on 7/19

– on 7/19, the S&P 500 bottomed 
– and rallied 6% over the next 12 trading sessions

Thus, if Thursday’s touch is analogous to 7/19, Thursday was the selling crescendo.  Not at the close, but in the morning session.

…”touch” or “extended inversion”: VIX inversions were seen at the last 6 market lows, but the duration is the question
It is probably self-evident that inversions in VIX take place at market bottoms — panic selling/ panic protection seeking.  But the key question is whether this inversion is:

– “touch” lasting 1-2 days –> market low contemporaneous
– “extended inversion” –> week long process and final low is at that last date

As shown below, since the March 2020 bottom, these inversions have lasted for a shorter and shorter period of time.  This has a few meanings:

– VIX was elevated in 2020, so inversions also lasted multi-sessions
– VIX level is now decline in a trend
– shorter inversions mean shorter corrections

If we had to guess, we think this episode will be a touch.  Why?  There are multiple reasons:

– Delta variant is running its course in multiple US states
– US yield curve remains steep, not flattening = constructive
– Investors are already showing signs of panic, particularly in sector rotation
– Anecdotally, we see lots of evidence of “half-full” interpretations

Largest ever UK study of vaccine effectiveness vs Delta: Half-full or half-empty? Depends on which continent
An example of this “half-full” thinking is the latest comprehensive study of vaccine effectiveness.  UK Researchers just published their findings from the largest ever COVID-19 vaccine effectiveness study, sampling >740,00 participants.  This study was unique because it looked at vaccine effectiveness over time and across Astra-zeneca and Pfizer’s vaccine.  There was limited review of Moderna’s.

– the key conclusion is two doses of either Astra or Pfizer significantly reduced risk of COVID-19
– even against Delta variant
– the WHO threshold is 50% effectiveness, and both Astra and Pfizer’s vaccine surpassed this, even after 4-5 months

– Pfizer’s effectiveness starts higher, however, after 4-5 months drifts towards the efficacy of Astra (which was more stable)

But the key conclusions of the authors is vaccine’s are effective against the Delta variant.  And there are some open questions, such as whether high viral loads of breakthroughs results in greater spread or whether this leads to more severe outcomes.

This chart from the report shows this time effect and both by age and overall:
– BNT –> Pfizer
– ChAdOx –> Astra Zeneca

You can see that Pfizer is superior but effectiveness does wane towards Astra, but not necessarily a material decline.

This second set of charts shows that the vaccine waning effects and also protection are impacted by co-morbidities and by having “previous infection”:

– a co-morbidity makes vaccines less effective
– prior infection makes vaccines more effective

Neither is a surprise, actually.

…Media coverage: One study, two completely different headlinesBut look at the media coverage of this study.  This is one study, but with two completely different headlines:

– BBC –> “covid vaccines still effective against Delta variant”
– Bloomberg –> “covid shots are less effective against Delta in UK study”

This is comical.  One study.  The results I showed above.  Two completely different stories.  I included the links to the articles.  And if you read both, you will have two completely different takeaways.  

Yup.  Half-full versus half-empty.

HALF-FULL OR HALF-EMPTY?  UK cases:  4 of 9 regions seeing sustained declines in cases, but 5 of 9 stubborn plateauAnother example is the UK case counts.  As shown below, the UK had a surge in COVID-19 cases from Delta and after a sharp fall, daily cases have been flattish.  But this is not the entire story.

…Looking at 9 regions of UK, shows that COVID-19 waning in 4 of 9 regions
Looking at the 9 regions tracked by the UK Health ministry, we see two divergent paths:

– collapses in 4 of 9 regions hit hardest by Delta, such as Yorkshire/ Humber and North East and even London, etc
– stable/slight rising in 5 of 9 regions

East and even London, etc
– stable/slight rising in 5 of 9 regions

The composite shows cases flat/ rising, but the actual diffusion, underlying trends are actually better than is apparent.

HALF-FULL OR HALF-EMPTY? Israel case prevalence vaxxed vs unvaxxed
Similarly, take a look at the active case data in Israel.  Israel is seeing a high level of breakthrough cases.  About 75% of Israel adults are vaccinated, leaving about 25% unvaccinated.  

– Israel is cited as example that vaccine effectiveness wanes over time
– thus, rising breakthrough cases –> true to an extent

But look at the composition of active cases.  The data is “right sized” using active cases per 100,000 residents:

– highest case rate –> unvaxxed age 90-plus –> 2,095 per 100k
– by comparison: vaxxed age 90-plus –> 607

– unvaxxed age 12-15 –> 916 per 100k
– vaxxed age 12-15   –> 103 per 100k

So, while breakthroughs are happening, the penetration or prevalence is far lower among vaccinated cohorts.

…divergence between vaxxed and unvaxxed soaring with time

In fact, look at the prevalence of severely ill patients below.  This is patients age 60-plus:

– fully vaxxed prevalence is up but a stable and low slope
– unvaxxed prevalence is exploding

To me, vaccinations seem to mitigate severe illness in Israel.

6 US states seem to have notable rolling over of cases, but 3 were false dawns

Earlier this week, we highlighted 9 states which seemed to have COVID-19 cases rolling over.  A good sign.  Updating this data, it looks like it is actually more like 6 states.  3 were false dawns:

– 6 states are CA, NV, FL, LA, AR, MO
– it took 34-60 days for cases to peak

But it looks like VT, AK and WA were false dawns, as cases are still rising in these states.  Still, COVID-19 is not rampaging through states indefinitely.  While Delta variant is highly contagious, it also seems to burn through a community faster than prior variants.  Thus, while COVID-19 cases are rising in US (not peaking as we had hoped), it is peaking in some states.

HALF-FULL or HALF-EMPTY:  COVID-19 waning dramatically in Latin America and India

One last observation.  It is winter in Latin America, so we would naturally cases to be surging in Latin America.  And the Lambda variant first emerged in Latin America.  And India saw the first reported cases of the Delta variant:

– Latin American cases rolling over hard
– India cases rolling over hard

So these two regions, hit hardest by a highly transmissible variant, are now seeing cases fall sharply.

BOTTOM LINE: Half-full or half-empty –> are headwinds structural or transitory

As this relates to markets, we think the key question is whether the headwinds identified Thursday are transitory or structural:

– Delta variant effect on consumer travel –> cancelled plans, permanent or transitory
– Collapse in soft survey such as consumer confidence –>  permanent or transitory
– Demand for oil, commodities –>  permanent or transitory
– Corporate uncertainty –>  permanent or transitory
– Questions of vaccine ability to neutralize COVID-19 –>  permanent or transitory
– Negative fallout for Afghanistan –>  Global economy impact permanent or transitory
– Collapse in investor confidence due to Delta variant risks –> permanent or transitory

If one thinks these are transitory, then one’s reaction to the market fallout would vary.  Based on our conversations, many investors seem to think these issues have become permanent and thus, are reducing their outlook for markets and upside potential.

…if it is transitory, this is a “buyer’s strike” which will naturally endOn the other hand, if these are transitory, then investors are simply going on a buyer’s strike now.  This is why trading volumes have been light, but markets have fallen sharply.

Our central case is “fuller risk on” into YE…

Our rationale for recommending Epicenter stocks is shown below.  Post-pandemic drivers favor Epicenter, particularly if we are going full risk-on.

– the key inflection in the past 10 days is the reversal higher in interest rates
– this becomes a big tailwind for Financials XLF0.55%
– this also is a tailwind for Energy XLE-0.25%  OIH0.63%  (see note from last week)

– we still like FAANG because there is a pro-cyclical element to FAANG FNGS1.43%
– there is also a catch-up trade for AMZN0.35%  AAPL0.03%  which are up a mere 2%/9% versus 18% for S&P 500

Energy is at 200D mavg, and we expect XLE-0.25%  to re-attain this –> stay out of the kitchen if you cannot handle “the fire”

Energy stocks have tended to have violent moves.  See the 45 day rate of change below (lower part of chart).  And as you can see, XLE is either soaring or falling, but with large magnitude moves:

– the sell-off since June has been staggering
– oil has fallen, but the reaction of Energy equities is outsized, because equities are more sensitive to buyer’s strikes
– but XLE-0.25%  is hovering near its 200-day moving average
– and the 200D shows XLE remains in a strong uptrend

If you think the risks outlined above are permanent, then Energy stocks will keep falling.If you think these are transitory, then Energy will resume a violent uptrend.

– COVID-19 cases could peak within days
– Booster shots bolster immunity
– Consumer panic means mitigation steps being taken

I am in the camp these are transitory headwinds.

Figure: Way forward ➜ What changes after COVID-19
Per FSInsight

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