Turning Points

Key Takeaways:

·        For equity markets, outcomes relative to expectations matter most. COVID-19 case outcomes in Western Europe and New York City are better than expected fueling a lift to equity markets.

·        The path to economic recovery most heavily influences whether equity market lows have been reached; medical developments and social activity guidelines hold the key.

·        We explore a path to new normal as outlined by former FDA Commissioner, Scott Gottlieb in his “optimistic, realistic” scenario.

·        Each day we move closer to the end of activity restrictions, we are nearer the economic recovery on the other side.

Green on the screen characterized a welcome lift to equity markets Monday. In what may be one of worst weeks for domestic COVID-19 cases, the direction and magnitude of the price move may have caught some by surprise. And yet for the equity markets, outcomes relative to expectations typically matter most. The expectations for rising case counts have been dire and the reality better than expected. New case count numbers suggest curve flattening in New York following stabilization seen in California and Washington earlier. In some of the hardest hit regions of Western Europe, including Spain, Italy and Germany, daily cases have decelerated over the past couple of weeks.

Social distancing is clearly working, yet not sustainable without significant economic damage. The economic reality of the second quarter will be dire and extremely difficult to forecast. Thankfully, Congress and the Federal Reserve implemented swift and massive economic support programs to build a bridge to recovery. At recent US equity price lows reached on March 23, the S&P 500 fell 34% from peak levels, consistent with average price declines seen in past recessionary bear markets.1  The path to economic recovery will most likely dictate whether this price marked the bottom in the current bear market. Medical developments and social activity guidelines hold the key.

Path to New Normal

In a report published with the American Enterprise Institute, former FDA Commissioner, Scott Gottlieb, outlines in detail A Roadmap to Reopening. In his interview with AEI (transcript here), Gottlieb presents the following, “optimistic, realistic” scenario. Following a tough month in April, the national epidemic peaks towards the end of April or early May. May is the transition month. Some of the (activity) mitigations start to lift. Regionally, shelter-in-place orders are lifted, but masks are encouraged. Spacing at restaurants and other group gathering spots have specific guidelines. Large group gatherings are discouraged. June is a more rapid transition with activity increasing but distancing still encouraged. By July and August, life gets back to something closer to (this new) normal; spreading has slowed meaningfully. By September, when seasonal risks increase, the hope is an effective drug will be identified. While a vaccine is unlikely until 2021 given the testing required, an antiviral or antibody treatment is certainly possible.

As activity restrictions are lifting, robust screening capabilities must be in place. Abbott Healthcare’s COVID-19 (15 minute) rapid-result test is game-changing. Yet capacity must increase as Abbott, Cepheid and others bring more tests online. Gottlieb believes testing capacity to facilitate more wide-scale screening will be closer to targets within 3-4 weeks.

As outlined in the Wall Street Journal article here, more than 140 experimental drug treatments and vaccines for COVID-19 are in development worldwide, including 11 in clinical trials. Including drugs approved for other diseases, there are 254 clinical trials testing treatments or vaccines for the virus.  Raymond James lead biotechnology analyst, Steve Seedhouse, PhD, assigns a 75% probability of success that we get sufficient evidence that hydroxychloroquine is effective in treating COVID-19 by the end of April.2 While it’s not a cure-all, it may help. The current Federal stockpile of hydroxychloroquine includes 29 million pills. Regeneron, using a rapid-response platform formed after the 2014 Ebola epidemic, found hundreds of antibodies that blocked the (COVID-19) virus from entering cells. If it couldn’t enter the cells, it couldn’t replicate. Clinical trials are planned for early summer; if effective, broader production could start by summer’s end.

Focusing on the Longer Term

While short-term uncertainty remains high, a depression scenario appears much less likely due to the significant policy response and additional economic support likely forthcoming. In her comments Tuesday, Nancy Pelosi discussed an additional $1 trillion in economic stimulus. Currently in place is $2 trillion in economic support alongside Federal Reserve lending capacity of another approximately $4 trillion.

More likely would be a steep and swift recession much of which was priced into the markets at recent lows. Given the near-term uncertainty, volatility may remain high. Markets rarely rally in a straight line. The bulls and bears typically continue their tug-of-war until the unexpected is obvious.

Yet valuations have reset to levels that for investors with a time horizon that extends 12-24 months or more present compelling risk-adjusted returns across credit and equity markets. Historically, equities bottom approximately four months prior to the end of recession. The current recession could be sharp and short (approximately 2 quarters) -- given scientific innovation in search of treatments and significant fiscal stimulus -- suggesting we may be nearing a bottom. 

We continue to favor high-quality assets with strong balance sheets and low default risk. It’s important to remember that 90% of the value of a stock is derived from future cash flows. Many stocks are pricing in low to negative earnings growth this year. As cash flows return and earnings expand, high quality stocks should recover. At current valuations, the premium investors are being paid to own equities over low-risk treasuries has rarely been higher.

While timing markets can be a fool’s errand, asking yourself the following questions is not. Which is your greater risk: the risk of losing money OR the risk of missed opportunity? How you balance these two can powerfully shape your investment decisions. Underlying the balance of these risks is your age, earnings power, and tolerance for volatility. The younger, more tolerant of market price swings, with strong current and future earnings power, the greater your potential risk of missing opportunities for possibly higher future expected returns. No matter your age, your portfolio diversification should reflect your specific needs and goals. An emergency cash allocation amply sized to cover 3-6 months or more of living expenses, dependent on your earnings power and income stability, strengthens your ability to stay the course with long-term investment decisions and sleep comfortably at night. While the short-term economic path remains unclear, each day we move closer to the end of activity restrictions, we are nearer the economic recovery on the other side.

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Footnotes: 1 Factset / 2 Raymond James Investment Strategy, 3/30/2020 Weekly COVID-19 Update Client Webinar 

Any opinions are those of Financial Advisors Catherine Trinder-Miller and Theresa N. Benson, CDFA and not necessarily those of Raymond James. The information contained in this article does not purport to be a complete description of the securities, markets, or developments referred to in this material. The foregoing information has been obtained from sources considered to be reliable, but we do not guarantee that it is accurate or complete. It is not a statement of all available data necessary for making an investment decision and does not constitute a recommendation. All opinions are as of this date and are subject to change without notice.

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