Markets Moving Higher on Expectations for Vaccine Success
By: Mitchell Anthony
November 25, 2020
Is the Covid Bounce Sustainable?
The distressed areas of the US equity market have rallied hard over the last few weeks pushing the Dow Jones industrial average over 30,000 for the first time. This occurred after three vaccine makers announced that they had achieved over 90% efficacy with their vaccines. This really exciting news caused investors to scoop up airline stocks, REITs, hotels, casinos, energy, and automakers. Since November 10th the equity market leadership has been dominated by highly distressed cyclicals and industrial names and other so-called re-open names in the equity market. We also saw strength in Biden industries including environmental stocks and semi-conductors companies that are poised to benefit from new policies that Biden plans to enact once in office. At the same time we have seen the stay at home names pause after a steady and substantial six month rally. The FAANG has been flat for the last three months while at the same time these distressed value names have advanced 5 to 10% or more. Is this three week move in these distressed areas of the market sustainable? How far will distressed areas of the equity market go on the come of substantial vaccine success? These are questions that we have been asking ourselves along with the rest of the Wall Street strategists who have pondered on the change of leadership that has just occurred over the last few weeks.
Given these unknown questions we have had to analyze market valuations both in the secular growth stay at home names as well as the cyclical distressed names. These stocks within these distressed industries for the most part are still well below their pre-Covid stock price levels but are selling at earnings multiples that are substantially higher than their pre-Covid levels. These high valuations seem to indicate that investors believe that the vaccine will be highly successful and will be implemented quickly and allow the globe to obtain herd immunity to the virus in 2021. Current estimates show that these three top vaccine manufacturers will have close to 6 billion doses available for distribution in 2021 meaning over 3 billion people can potentially be vaccinated next year. The population of the globe is approximately 7.7 billion and the US population is approximately 350 million. This exciting news clearly has caused some euphoria in the market and pushed the Dow Jones industrial average to record highs of over 30,000.
The US Economy is Lagging US Equity Markets
This rally in the distressed areas of the equity market came after the announcement of the vaccine success and high efficacy, and occurred at the same time as an acceleration in cases of the virus occurred in the US and across the globe. Investors were clearly more interested in the success of the vaccine then the news of the re-acceleration of the virus. It is unclear whether or not this sentiment will stick or possibly reverse as the virus accelerates further. The acceleration of virus has caused regulators to order renewed lockdowns forcing businesses to close or reduce services. As a result the US economy is rolling over a bit just as these distressed cyclical markets have rallied. The markets are obviously on a delicate path as they balance optimism about a return to normal conditions in the economy with further lockdowns in the near term.
The rally in the cyclicals and industrial names has been so strong that it would seem that investors are not only discounting in a return to normalcy in the US economy but an actual path of stronger growth on the horizon then the pre-Covid growth path that existed in 2019. Economic Outlook in 2021 is still very difficult to forecast but with current valuations in distressed areas so high it would seem that investors are very optimistic about strong growth in 2021. The other question that is obvious involves what sort of consumption lies beyond the vaccine? Is there pent up demand in the economy that could stimulate higher and higher levels of consumption and growth? The growth in the Economy feeds upon itself and consumption begets more consumption.
The three month trends in consumption of travel, hotels, meals, are all good. Broad economic trends are also good. Employment, retail sales, auto sales, home sales are all trending higher. Unfortunately the US economy is currently back on a path of economic shutdown and very recent consumption data is trending lower. Very recent data shows that Restaurant sales are rolling over, Travel is Soft, and Hotels are soft. This is all occurring while we are preparing for extended unemployment insurance to run out, along with the eviction moratorium, new mortgage forbearance, and deferral of student debt payments. How much more damage will occur to the front line industries as we await the vaccine and herd immunity?
The Outlook for the US Economy
Current Expectations for economic growth are modest to moderate but are clearly rising. There is an Improving outlook for DISTRESSED Cyclicals and Industrial sectors of the US economy. Again the question is will the Vaccine bring back normal operations of Cyclical Business? It would appear that there will be No quick return to gathering oriented consumption. We expect a linear path of recovery in the consumption of retail and consumer services over the next 12-24 months.
We believe that the pent-up demand for durable goods like autos along with entertainment, travel, and leisure activities will likely lead the economy to stronger growth than we had pre-covid. We believe that strength begets more strength and that the rising consumption from pent up demand will feed upon itself. We also believe that consumers will be able to spend more by using cash freed up from recent home refinance programs, as well as use of cheap home equity lines. We know that consumers house is their biggest asset and it is important to note that this asset has performed well during Covid. We also note that consumer credit card debt actually decreased from 2019-2020. This all turns into increased consumer confidence and higher levels of consumption.
On the flipside there are some obstacles in the path of recovery and higher levels of consumption and growth. There are higher levels of debt for corporate America today than pre-Covid. This is a manageable problem it would appear as the Fed has insulated corporate America from the high cost of borrowing that might have occurred during this type of crisis. The Fed has made it clear he will be the lender of last resort for these distressed areas of the economy and he will keep these industries standing strong through the crisis. The other problem involves stimulus that has not happened that was promised by Washington. The divided Congress seems unlikely to pass any stimulation plan as long as it involves any bailout of distressed states prior to Covid. As a result stimulus still seems unlikely despite more lockdowns and tighter regulations on gathering.
The Outlook for Tech and tech fueled industries is high and on a stable path of growth in demand as the Covid changes in the economy seem mostly permanent.
The Outlook for Equities
The outlook for equities in general is still quite bright given the monetary environment that is forcing investors to continue to embrace risk. The most compelling valuations continue to exist within secular growth names that are tech or tech enabled industries. This is where the emphasis is in our portfolio and has been for several years. We do not believe that Covid has damaged the secular growth themes in our economy but in fact has enhanced or added to existing secular consumption themes for tech and tech enabled industries. We believe that the economy will emerge from the Covid crisis likely stronger because of all the liquidity that has been poured onto the problem. We also believe that pent up demand will feed higher levels of growth and consumption and will push valuations in industrial names and cyclical names higher, but the growth in these equities is unlikely to match or exceed that of secular growth names over the next year but may outperform over the next 3 to 6 months. The best opportunities exist in the most distressed areas due to Covid. This would include airlines, casinos, restaurants, hotels, and entertainment in general. These areas were not great growth areas or even good growth areas prior to Covid and are unlikely to become great growth areas post Covid but will likely see higher levels of growth and consumption than is currently expected.
The stay at home secular growth names have been flat for the last five months despite very visible strong earnings growth that is laying the foundation for higher prices. We continue to believe that the FAANG will outperform the broader market. Some areas of the secular growth stay at home names will likely see their growth subside a bit as Covid becomes contained and eliminated. This would include home entertainment, home exercise, home improvement, and take out and home dining.
Stocks are moving higher undoubtedly and the distressed cyclical names offer some opportunity for the tactical asset allocation employed by MACM and short-term investors.
We remain optimistic