Second Wave Considerations
Concerns about a second wave of contagion remain widespread as states move deeper into the reopening phase. A significant subsequent wave of COVID-19 cases continues to be widely referenced as a potential catalyst for a second leg lower in equities. However, as the four points below suggest, we believe it is possible that markets have already priced in many of the risk dynamics related to a second wave.
- A better handle on COVID-19 “uncertainties” has been established.
As of late June, approximately 122,000 deaths have occurred in the US as a result of COVID-19. This is without question a national tragedy. Yet, remaining mindful of pandemic victims and their families is as important as recognizing that American healthcare professionals have proven they can handle the outbreak. Nurses, doctors, administrators, paramedics and frontline workers of all kinds have saved thousands of lives and helped to prove that COVID-19’s fatality rate is lower than was initially feared. They deserve our appreciation and thanks.
- The lockdown and reopening was never about the total eradication of COVID-19.
The US, like many countries in Europe, reacted too late to contain the pandemic. The federal government, state governments, and public health systems moved too slow and were unprepared for the virus once significant contagion became apparent. There seems to be consensus understanding that any viable treatment or vaccine is – at the very least – 6 to 12 months away. Vaccine and pharmaceutical specialists in the US, India, China, and elsewhere are working to compress standard procedures that can normally take a decade or more into a matter of weeks. They are working urgently – but ending the lockdown was never contingent on the discovery of a vaccine. The lockdown was required to gain a better understanding of the severity of the virus, work to stem the contagion, improve testing, and achieve some clarity around COVID-19’s fatality rate, and important progress has been made on these fronts. What’s more, national hospital capacity figures suggest that healthcare systems remain prepared in the near term for an influx of patients as hospital capacity remains available. In addition, there is no evidence that COVID-19 has evolved to become more lethal or begun to cause unexpected increases in fatalities. Thankfully, the majority of cases continue to be treated successfully by individuals who self-quarantine at home.
- Second wave or first wave continued?
While nationwide case counts stubbornly plateaued through much of May, recent case counts have been inflecting higher. But it’s important to note the widely publicized case increases in Arizona, Texas, and other southern states are not reflective of a “second wave” but instead the “first wave” in states that hadn’t dealt with considerable outbreaks to date. While this may seem nuanced, it is a meaningful distinction and the response to such increases provides no insight into what a true “second wave” looks like or what the policy response will be.
In addition, these rising headline case counts are being driven largely by localized outbreaks in prisons, meat packing plants, and agricultural pickers. This is not to downplay the spread in these populations, but rather to highlight the concentrated nature of the outbreaks. Furthermore, increasing counts in the south and west belie significant progress being made in early hotspots on the east coast. And more importantly to markets, states currently seeing increasing positive test rates – suggestive of increasing cases that are not the result of increased testing efforts – only represent about 10% of US GDP. A handful of states do not represent the entire country.
- Lockdowns can be effective with less economic fallout.
The first wave of lockdowns were hastily and broadly implemented. A growing body of evidence suggests that COVID-19 spreads primarily through prolonged indoor contact. While some pockets of the economy will continue to struggle in the age of social distancing, many parts of the economy can adapt. Lockdowns need not look like they did in March and April. Instead, case counts can be countered with less draconian measures such as prohibiting indoor dining and large gatherings and encouraging work-from-home protocols for those that are able. For other indoor activities, perhaps masks are mandated. Many of these measures are already being implemented in reopening plans across the country. We have already begun to adapt to this new normal, and it appears to be increasingly likely that further “lockdown” measures, if required to halt contagion, can be far less economically devastating and likely far more localized in nature.
The effort made by healthcare workers to stem the tide of cases in early 2020 has proven vital, and its importance cannot be stressed enough. The suggestion that the US requires vast improvements in testing and contract tracing has been widely discussed. While this approach has been successful in South Korea, it appears less and less likely that the US will be able to successfully implement such a system in a timely fashion. Moreover, the country’s deeply held traditions of civil liberty make the prospect of implementing more intrusive contact tracing initiatives, as well as continued or expanded state-mandated containment measures, politically daunting.
The health risks related to COVID-19 are real – continued adherence to social distancing measures, handwashing protocols, and the use of masks are crucial components of containing further spread of the virus. However, we believe markets have priced in a second wave of cases and begun to account for the ability of the healthcare system to contend with it. Of note here is that in some states hospitals are starting to implement road maps for bringing elective procedures back on line.
Slow and Steady
The economic reopening remains slow and measured. Restrictions remain in place and in most places will only be lifted with extreme caution in the attempt to slow the spread of a second wave. While no one is expecting 100% across-the-board participation in containment measures like handwashing and face masks, awareness about the dangers of the disease and how it spreads has become “the new normal.”
It also remains likely that the hardest hit areas of the country will be better at self-policing for COVID-19 than areas that were spared the worst of the initial outbreak. While these areas may disregard containment measures in the early stages of outbreak, it’s also possible that the local threat of the virus will elicit more adherence and help to limit the size of any new outbreaks. In addition, there is evidence that the virus may have been in the US earlier than initially thought. As a result, it’s possible that the number of people who have been infected by the virus is higher than we know, including asymptomatic cases or cases presenting only minor symptoms. This is not to discount the serious health risks associated with COVID-19 – this is not just “the flu” – it only means that important work on how the disease spreads and manifests continues.
Maintaining Risk Mindfulness
While the situation remains fluid, we believe as of early summer that unless we see things turn more dire – including an increase in COVID-19’s lethality or evidence of a renewed strain on healthcare systems – a measured nationwide reopening will continue through the end of the year. The experiences of early 2020 have the potential to help address and contain a significant second wave of cases, allowing for a gradual reopening and the establishment of a new way of life. The stock market is not the economy. Large index players appear to be virtually unaffected by COVID-19, and they are likely large enough to play a role in holding up the broader market. More importantly, strength has rotated from exclusively these large tech firms and other beneficiaries of the new normal economy to include more cyclical sensitive sectors, an important signal that the recovery in asset prices is indeed sustainable. While we believe we will see business failures, we do not believe they will occur on a scale that significantly threatens the long-term survival of the US economy. In addition, the number of the COVID-19 business closures could be contained in part by merger and acquisition activity in a world where distressed managers are looking to sell. In the meantime, risks that we are watching include:
- Increasing political partisanship around federal aid dollars as the November 2020 US elections draw nearer.
Should legislators decide that politics are more important than the economy or that recent economic data surprises suggest further support is unnecessary – particularly for state and local governments – a multitude of problems could follow. In this scenario the market might force Congress to react.
- An unexpected and significant increase in fatality rates.
As discussed above, there is evidence that healthcare systems can handle large numbers of COVID-19 cases in terms of treatment. Nonetheless, evidence of increasing virus lethality has the potential to reverse hard-fought gains.
- Consumers and business retrench.
The COVID-19 experience is unparalleled in a modern economy – nobody can say for sure how consumer spending might look coming out the other end of the crisis, or know in advance exactly how the allocation of capital on the part of businesses might change. Debates about data collection aside, an improved employment picture in the May 2020 jobs report was a cause for optimism, and the slow but steady improvement in high frequency mobility and consumer spending data continue to point toward an economy on the path to recovery.
- The liquidity backdrop tightens.
While it’s impossible to say exactly how or why this might happen, that it occurred at the beginning of the crisis served as a surprise for many. The Fed remains on high alert and is in “whatever it takes” mode to prevent a credit crunch from happening. The Fed’s actions have proven successful, and that’s commendable. In fact, we believe markets and investors may be continuing to underestimate the historic size and magnitude of the fiscal and monetary response to the COVID-19 pandemic worldwide.
- Market sentiment and positioning becomes “offside bullish.”
By “offside bullish” we mean an overestimated recovery. Admittedly, we are a very long way from this as of late June – but we believe it’s worth keeping in mind. To take one example, the March selloff saw nearly $100 billion redeemed out1 of ETF2 and Long-Only3 equities. In the 12 weeks since the March lows only $10.5 billion has returned – not exactly bullish. If anything, the sharp and significant rally in asset prices has helped to curtail excessive optimism on a broad scale.
Plenty of unknowns remain, as do a multitude of risks. COVID-19 has drastically changed life as we know it. Still, much work has been done to answer the call, and this work continues. Regardless of whether or not you take a bull or bear perspective on the remainder of 2020, our guess is you’re doing so with a bit more humility and gratitude.
2 An exchange-traded fund, or ETF, is a marketable security that tracks an index, commodity, bonds, or a basket of assets like an index fund. ETFs trade like common stock on a stock exchange and experience price fluctuations throughout the day as they are bought and sold.
3 Equity Long-Only or Long-Only equities is a type of investment strategy that utilizes only long positions in the assets it owns, with “long” referring to the expectation that the asset (stock, commodity, or currency) will rise in value over time. This approach is used by many hedge funds.
The views and opinions expressed may change based on market and other conditions. This material is intended for informational purposes only, does not constitute investment advice and should not be construed as a recommendation for investment action.