Maybe We’re Worried About The Wrong Tail Risk

Jim Bullard said Friday that the spread of the Delta variant is likely to be a temporary issue. Or maybe “transitory” is better.

He also struck a decidedly hawkish tone when it comes to tapering asset purchases, something he said the market is “very much ready” to digest. I “very much” doubt that assessment of market preparedness. I’m sure you do too.

His take on inflation was borderline alarmist, or at least as policymakers go. “We should go ahead and get the taper going… so we would have some optionality to handle the possibility — maybe not even the likelihood — that inflation is more persistent and higher than we’d like,” he said, in remarks to reporters cited by Bloomberg.

Bullard thinks waiting until next year to start the taper might be a mistake. “I would say that’s a risky strategy — you might have inflation running at an even higher level than you do today,” he mused. “I think you would get behind the curve.” He also said that eventually, the Fed may “have to raise [rates] substantially to put downward pressure on inflation” if the Committee stays “out of position.” His base case is for a rate hike in Q4 of next year. Although he sees price pressures moderating in 2022, Bullard does expect some “impulse carryover.” He was very bullish on growth.

Although this is decidedly out of step with most of the analyst commentary I’ve read recently, the bigger risk seems to be the Delta variant. The headlines get worse by the hour. Mask mandates are coming back, more and more companies are mandating vaccines as a condition of employment and, as most readers are probably aware, the Biden administration is palpably nervous. In addition to mandating vaccines for federal workers, the White House asked state and local governments to hand out $100 to unvaccinated individuals who voluntarily get the shot. It seems likely that, at some point, Biden will mandate vaccines for all active-duty members of the military, something he can do as commander in chief.

The rhetoric is urgent. “People are dying who don’t have to die,” Biden said Thursday. “If you’re out there unvaccinated, you don’t have to die.” He also had a message for federal contractors: “If you want to do business with the federal government, get your workers vaccinated.”

This isn’t a joke anymore. I mean, it was never a joke, but it feels like many market participants may be worried about the wrong thing. The latest edition of BofA’s Global Fund Manager Survey showed COVID worries falling to fifth on the tail risk list (figure below).

Effective immediately, Walmart is requiring masks for workers in stores located in high-risk counties as defined by the CDC. It doesn’t matter what your vaccination status is if you work at one of those locations. You’ll be wearing a mask or you won’t be working, apparently. As the AP noted, “the company is also bring[ing] back so-called health ambassadors who will be positioned at entrances [and] doubling the incentive for workers in stores, clubs, transportation and distribution centers to get the vaccine.”

Apple is reintroducing mask mandates in most of its stores, both for workers and shoppers. “After carefully reviewing the latest CDC recommendations, and analyzing the health and safety data for your local area, we are updating our guidance on face masks for your store,” a memo to affected staff said. “Starting July 29, face masks will be required in store for customers and team members — even if they’re vaccinated.”

As of Thursday evening, the list of companies requiring vaccinations for at least some employees included Google, Facebook, Netflix, BlackRock, Morgan Stanley, Saks, The Washington Post, Lyft, Ascension Health, Uber and Twitter. An internal CDC document detailed Thursday suggested the Delta variant is more transmissible than the common cold and as contagious as chickenpox.

Apple’s store mask mandate was characterized as a decision taken “out of an abundance of caution.” As alluded to above, many market participants don’t seem very cautious, and I don’t necessarily mean that in the generic context of rising equity prices.

Once again, you can feel an almost conspiratorial cadence creeping into the discourse, as war-weariness and frustration produces derisive references to health officials, doctors, government agencies and, more generally, science.

Inflation, meanwhile, is regarded by analysts, traders and investors with the kind of dread otherwise reserved for Ebola and Pazuzu.

When it comes to the notion that the Delta variant shouldn’t be cause for overwrought hand-wringing among the vaccinated, I suppose I’d quote Sigourney Weaver’s Ripley, who, in one of countless famous scenes from “Aliens,” told skeptics, “I hope you’re right. I really do.”

One person who isn’t convinced is Guggenheim’s Scott Minerd. Admittedly, I’ve had all manner of fun at Scott’s expense over the years. My opinion isn’t a secret: I think he’s a publicity seeker who loves to see his name next to bombastic quotables, bearish, bullish or anything in-between.

Credit where it’s due, though. He did predict, on television, that COVID-19 was poised to spiral out of control imminently, just days before it actually did. “Scott Minerd Woke Up On The Armageddon Side Of The Bed This Morning,” I joked, on February 27, 2020. The joke ended up being on me (even as that title was undeniably funny).

On Friday, Minerd dialed into CNBC’s “Halftime Report.” Roll your eyes as you will, but at least it’s preferable to another Jeff Gundlach cameo.

Referencing a note (read: public blog post) published Friday, Minerd told the network’s Scott Wapner that, “If things couldn’t be better, there’s no upside left. You might as well go to cash.”

“While I think the expansion has legs and lots of room to run… the surge in the pandemic is mind-numbing,” he said, adding that, “this feels exactly the same” as February 2020, when the market “was ignoring it” on the way to new highs. “If we’re going to have lockdowns, which I think will be highly likely, it’s going to affect the economy,” Minerd continued. “It might be a good time to take some risk off the table and save some dry powder for the possibility that we could see a severe correction.”

Pressed about the vaccine providing protection against hospitalizations and death, Minerd conceded that “I’m not an expert in this.” Still, he warned that to the layperson, the transmission rate looks worrisome. “With only half of the country vaccinated… I think we’re going to get a surge in cases,” he said.

From there, Minerd speculated a bit on the viability of plans to re-open schools and the read-through of a prospective delay in a return to in-person learning for parents and the workforce.

The point isn’t to present Minerd as some kind of authority. I’ve taken to completely ignoring almost everything he writes and says because although I appreciate why people enjoy his musings, I simply don’t. The point in mentioning his remarks on Friday is that I think it’s worth considering whether we’re worried about the wrong thing. Here are two excerpts from Minerd’s “outlook” post:

At this incipient stage of the spread of the Delta variant and slowing of economic growth, there are enough red flags that prudent investors have to start considering de-risking. Even if the outcome is not as severe as last year, we still can expect significant volatility in the weeks and months ahead as the market prices in a rising level of uncertainty. With the likelihood that COVID will once again adversely affect economic activity, risk assets look extremely vulnerable against this economic backdrop.

Once again we find ourselves outside of the consensus opinion. As far as markets and the economy are concerned, “Things couldn’t be better.” If that’s the case, I guess it’s probably time to sell!

I don’t know about that latter bit. It was certainly “time to sell” in February of 2020, when Minerd told Bloomberg’s Joe Weisenthal that COVID was “possibly the worst thing I’ve ever seen in my career.” But don’t forget that less than a month later, it was “certainly time to buy,” when equities embarked on one of the most spectacular rallies in a century.

The point, then, isn’t to make any predictions about equities. Rather, I think it’s important to highlight the distinct possibility that market participants are ill-prepared for another virus scare. Some of the same portals responsible for spreading the kind of misinformation that’s contributing to vaccine hesitancy are widely-followed by investors, and routinely traffic in inflation ghost stories.

Additionally, some widely-followed “financial” websites, Twitter accounts and even professionals, harbor what I’d describe as an ingrained penchant for misplaced notions of Santelli-esque faux libertarianism. Irony atop irony, that contributes to complacency around virus risk and thereby increases the chances of a drawdown, which some of the same portals and people would monetize via bombastic content and soundbites.

Invariably, some of those folks cited Minerd on Friday. That’s how the propaganda echo chamber works. And how folks get unwittingly swept up in it.


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13 thoughts on “Maybe We’re Worried About The Wrong Tail Risk

  1. My feeling is that another Covid surge started getting priced into some individual stocks for at least a couple of weeks. Look at the up moves in vaccine names (BNTX MRNA), testing names (PKI, DHR), the takeoff was mid July.

    If the surge were to have major economic consequences, I’m not sure that is priced in – well, based on BAML FMS I guess it isn’t. Will it? A few possibilities:
    – disrupts supply chains even further (happening overseas to some extent, not in the US part of supply chain yet)
    – suppresses some types of consumer activity (seems likely to see some of this in 3Q)
    – slows business hiring right about when UE benefits end (I’m doubtful this happens, but would be grave)

    By now there have been many Covid surges in the US and elsewhere, and investors can estimate the duration of the rise – 2 months? 3 months? – and get ready to pile into the most-impacted names as soon as the new case curve starts rounding over.

    What else I’d guess is not priced in?

    First, if there is something very different about the current virus variant – much higher immune escape, much greater acute severity (IFR, CFR), or much greater chronic disease (long Covid), let’s say.

    Second, if vaccination fails as a way to permanently control SARS-COV-2 – such that masking and other NPI, and major Covid surges, become a permanent part of our future.

    1. JYL, to your initial point, look at the mirror-image downward price action in energy, airlines, cruise ships, etc. in July. Certainly some COVID surge getting priced in there, beyond the overall Growth + Defensives > Value + Cyclicals sentiment during that time.

      1. Yes, Delta surely contributed there as well, though it is hard to say how much was second derivative and peak recovery stuff. I took profits on a bunch of that stuff in the past couple months, and am mulling over whether to jump back in at peak Delta, which i surmise could be Sept/Oct-ish.

  2. In an odd way, the Delta variant is like high prices, in that the cure for it is more Delta spread. IOW, as more unvaccinated people die or fall seriously ill from the virus, more unvaccinated people will decide to get vaccinated. Baring the emergence of a more virulent strain, we should be close to herd immunity in the places where most of the country’s GDP is produced by 1Q22. If that’s the case, the Fed should start to taper purchases of MBS — say, $10m a month for a quarter, then ramping to $20m a month a quarter thereafter — in 4Q21. That might take the indices down 10% over a few months, but it will put a lid on soaring housing prices and knock a few points off of inflation, setting us up for a more sustainable recovery in 2H2022-23.

  3. In the UK, Delta cases started rising in June and are possibly peaking, based on a review of Worldometer data. Although deaths have risen, the total number of deaths are quite small compared to deaths occurring during previous surges.
    This is happening against a backdrop of businesses, pubs, etc. remaining open.

    In the US, if the older/more at risk are already mostly vaccinated, this fall is hopefully no worse than a lot of people getting sick (but not bedridden) with minimal hospitalizations/deaths resulting. Businesses will be open and bars will be packed with young people who have cold symptoms. I remember fondly the days when I went to the bars more worried about what I should wear than whether I or others had a virus. Now, I have the complete opposite concerns.

    I am expecting that going forward, over the next 6 quarters, corporate EPS can handle some covid, some inflation, tapering, and small interest rises, “scheduled” for 2023…..or even a bit sooner.
    Seriously, doesn’t the reaction to Amazon seem a bit excessive?

    1. See link for US vax rate by age.

      Pretty high for the very oldest groups, but by the 50-64 group the rate of fully vaxed is down to 60%-ish and drops from there. If this data were broken out by state, some states would have much lower rates.

      The Delta variant is so transmissible, around 2X more than the original strain, and Americans are taking so few precautions, that this will, I believe, be the biggest surge yet in number of cases.

      In number of hospitalizations and deaths . . . we’ll see. The UK experience is hopeful, but their vaccination pattern is very different than ours. See UK vax rate by age here

      Logically, I don’t really see why the US should count on having as fortunate a hosp/death outcome from this surge as the UK has had (so far).

      I think H had a post that made this point, a couple wells ago.

  4. With respect to libertarians, I would like to say that the French have it correct with their national motto.

    Liberte, Egalite, Fraternite

    The underlying, but not overtly stated principal is that this expression is a tripartite, essentially meaning those 3 words are part of a singular concept and you do not get to “pick and choose” just one word in the motto that you want to follow.
    There should be a better balance in all of our national discussions between individual rights and the greater good. Sometimes, we just have to agree to something, whether we like it or not, for the greater good.

    1. The vast majority of Americans don’t have the slightest conception of what a libertarian even is and, as I’m fond of putting it, couldn’t name a libertarian thinker if their lives depended on it. It’s just an excuse for people to complain about things they don’t like. Anything that’s disagreeable is framed as an assault on their “liberty.” Americans used to make the same argument about seat belts, but eventually they got bored with it because arguing over a piece of fabric with a buckle attached to it just wasn’t very exciting.

  5. I have to say that Pazuzu reference is pretty neat. For what is worth the Delta sequel to the pandemic might scare the markets as Minerd suggests, but I doubt it will be anything close to the scare caused by the original wave and strain, just as the Exorcist II lacked the impact and fear of the original Exorcist, even with Pazuzu in the story.

  6. I am sure that H will disagree with me as he normally does, but has not the idea of a vaccine passport come and gone? If you are vaccinated, you can still have the delta variant and spread it so why mandate employees have the vaccine or indeed force people to prove they have had it if it does not prevent spread?

    1. Cases among vaccinated employees will probably be milder so they can get their butts back to work quicker without any of those expensive hospital bills that drive up insurance costs.

    2. Reality is not binary, black or white, absolute yes or absolute no. It matters if “can” is 85% probability or 15%. The inability of many to comprehend decision making in a grayscale world is one of our largest problems right now.

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