A wing and a (vaccine) prayer.
That’s what equities are living on headed into the back half of 2020.
It’s an admittedly pessimistic way to conceptualize things, and it probably overstates the case. Not everyone who harbors a constructive outlook on risk assets is counting on a vaccine being delivered along the Trump administration’s extremely optimistic timeline.
But without a vaccine (and lacking herd immunity), it’s possible the economy simply will not be able to regain its joie de vivre — or at least not entirely. Most Fed officials seem to hold that view, as do some economists.
I would argue that what we’ve seen in terms of surging retail sales and various other inflections in the data over the past several weeks is just a combination of i) pent up demand, ii) fiscal initiatives that have put money in folks’ pockets and compelled businesses to rehire, and importantly iii) an inevitable bounce from the lowest levels in history on some indicators.
The reimposition of containment protocols across Texas, Florida, and Arizona is by now well documented, but it feels a bit like everyone is pretending it’s not going to have an economic impact. Spoiler alert: It will. It’s just a matter of whether concurrent re-openings in other states offset the effect at the aggregate level.
I hesitate to keep rolling out the charts, but just to underscore the point, the situation in Texas is totally out of control. The hospitalization count is rising inexorably.
The market’s reaction to ostensibly positive vaccine news on Wednesday in the US was telling.
A modicum of progress in an early-stage human trial of an experimental vaccine from Pfizer was enough to spark a reversal in equity futures, which were moving lower at the time.
The news got lost in the data shuffle, but the point is, no matter how many other factors bulls cite when it comes to justifying a constructive take on equities after the best quarter for the S&P since 1998, subconsciously, a vaccine is part of the thesis. If there’s no vaccine, then this fight (against COVID-19) is going to drag on for a long (long) time.
As discussed at length on Monday (see here) some believe earnings forecasts have troughed. Indeed, RBC’s indicator showing the share of upside revisions just ticked above 50% for the first time this year. It was in the single-digits at one point after March’s malaise.
As Bloomberg’s Sarah Ponczek writes, this is beginning to show up in factor behavior, as both target price and EPS revisions have been among the best performing factors of late.
But here’s the problem. Earnings are going to be a disaster. After Q1’s 15% nosedive, profits are expected to contract more than 43% for the second quarter, 25% in Q3, and 13% in Q4.
The juxtaposition between that and where consensus was prior to the pandemic is wholly laughable — well, it’s laughable if you can get past the fact that the proximate cause of the problem is a deadly respiratory disease that’s killed a half-million people.
Remember: The US was already in an earnings recession (basically). The market was looking for a “hockey stick”-style inflection out of that in 2020. Instead, we got a pandemic and the worst economic collapse in at least 100 years.
In her piece, Ponczek picks up on the fiscal cliff problem, something I’ve discussed here nearly every, single day for weeks. This month, taxes are due and some extra unemployment benefits associated with the virus relief bill will roll off.
“As it stands, the unemployment benefit boost created by the CARES Act is due to expire at the end of July”, Ponczek reminds you. “That’s significant considering many bullish bets are predicated on stimulus measures — both fiscal and monetary — and viral spread not getting out of hand”.
The figure (below) is crucial.
Kevin Muir (formerly head of equity derivatives at RBC Dominion, and better known for his exploits as “The Macro Tourist”) zooms in on this in a note dated Wednesday.
When you take a look at the yearly change, adjusted for inflation, you can see how the COVID crisis is different.
“This recession has been dramatically different from the previous ones”, Kevin writes, in the course of cautioning that “a failure to roll corona-crisis benefits, or an increase in layoffs from a worsening of the virus, could cause total labour compensation to experience a more normal recessionary collapse”.
He doesn’t venture any predictions about what’s likely to happen next in negotiations around another virus relief package. That’s probably smart — even Beltway insiders are flying blind to a certain extent right now, given partisan gridlock, the proximity of the election, and the sheer indeterminacy of the biological threat.
Rather, Kevin’s point is simple. “Too many pundits are claiming markets are disconnected from fundamentals”, he writes. “But maybe they’re watching the wrong ‘fundamentals'”.