Our previous belief that the emergence of a second wave of the coronavirus pandemic could hit the US has turned to, more or less, certainty that the US is experiencing a second wave right now. This is bad news, but luckily, it looks like the second wave may be a less dramatic one compared to what we witnessed in New York a couple of months ago, due to some differences we will explain in this article.
We also want to shine a light on stocks that could provide protection if the amount of cases continues to rise over the coming weeks, while highlighting sectors that could be vulnerable and may better be avoided.
The “Second Wave” Looks More And More Likely
In a recent article from a little more than a week ago, we warned that a second wave could occur, based on a reversal in the trend of newly diagnosed COVID-19 infections in the US. Since then, things developed more or less as we predicted, with the case count continuing to climb on an accelerating trajectory:
Source: New York Times
We clearly see that the amount of newly diagnosed cases, which had been trending down between mid-April and early June, has accelerated meaningfully over the last 3 weeks. The 7-day average of newly diagnosed cases has taken a steep upturn, and daily cases are significantly above the 7-day average right now. This, in turn, means that the 7-day moving average will in all likelihood continue to rise in the near future. Even worse, new daily cases just set a record high, surpassing the previous peak from April.
The recent rise in newly diagnosed cases is primarily driven by states that were not hit too hard during the first wave. New York and New Jersey, the hardest-hit states during March and April, are on a solid trajectory when it comes to new cases, but states such as Florida, Texas, and California are seeing a sharp rise in cases. The exact reasons that are causing this rise in cases are not fully known, but it seems likely that multiple factors play a role. This may include the Memorial Day celebrations, reopening across a range of states, protests with large crowds, a change in behavior by the younger generation. It is very much possible that additional factors play a role in the recent resurgence of new cases.
In our previous article, some readers mentioned that a rise in newly diagnosed cases may stem from increased testing. This does seem logical – if testing is increased, more cases with no symptoms or very mild symptoms are discovered, thus the total case count rises. But this cannot fully explain the rise in newly diagnosed cases, as the positive test rate is climbing in several key states. The positive test rate in Florida, for example, has risen to ~20% from less than 10%, thus the rise in cases in the state is not explainable by increased testing alone. In a similar way, the positive test rate in California has also jumped upwards, which means that community spread in this state must be increasing. Testing in the US, overall, may not be sufficient yet – the Johns Hopkins University recommends that positive testing rates should be at 5% or below, a level that is surpassed by many states:
So we can summarize that newly diagnosed cases are clearly rising, even setting new record highs, and that this cannot be explained by increased testing alone. The growing positive test rates in several key states show that community spread must be increasing. The reasons for that are likely including reopening efforts, less focus on social distancing, etc. We think that this warrants the statement that a so-called “second wave” is underway. Is this bad? The answer probably is yes. But luckily, not everything is going in the wrong direction, it looks like a “New-York-scenario” could be avoided. This is due to the fact that the demographic that is being infected now is somewhat different compared to March and April. Increasingly, COVID-19 cases are diagnosed among younger adults. These younger people are, of course, not invulnerable to the disease, but the likelihood of a severe cause of the illness is lower for a 20-year old compared to more senior persons. This, in turn, means that a lower ratio of diagnosed patients will require hospital care, which makes it less likely that the healthcare system gets overwhelmed. At the same time, authorities now know about the vulnerability of senior housing facilities, and efforts to combat the spread of the virus among residents have been increased. We can thus summarize that it looks like the US is experiencing a “second wave”, yet this new emergence of the virus may be less deadly compared to what happened in March and April, when a disproportionate amount of vulnerable persons were infected. Hopefully, states in which the virus is spreading now will thus be spared from experiencing what we witnessed in New York this spring.
What Does It Mean For Investors?
Stock market volatility remains high but has come down from the levels seen in mid- to late-March, as the CBOE Volatility Index (VIX) stands at 35 right now, versus 80 at the peak. This is, however, still more than twice the reading from the beginning of the year.
At the same time, the broad market has recovered most of the losses that it experienced in March: The S&P 500 index (SPY) is down 6% year-to-date, the Dow Jones Index (DIA) is down 11%, while the Nasdaq-100 (QQQ) has risen by double digits so far in 2020. Much of the recovery across equity markets that was experienced in April and May can be attributed to ultra-lax monetary policy, we believe, as printing trillions of dollars clearly impacts equity prices. The huge amount of newly-printed cash makes it less likely that we will experience another violent sell-off like the one from March across broad markets, we believe. And yet, it is not reasonable to assume that the emergence of a “second wave” will not impact equity markets at all.
We believe that “fighting the Fed” may not be a winning strategy, and we are not necessarily bearish on the S&P 500 index. This is due to the fact that the broad market is heavily weighted towards technology, which has been a winning industry during this crisis. Amazon (AMZN), Microsoft (MSFT), Alphabet (GOOGL), and many other tech companies have not been hit hard by the coronavirus during the first wave, and it is reasonable to assume that they will not be hit hard during the current reemergence of the virus. Shorting an index that is heavily weighted towards these companies, while the Fed continues to print new money, is thus not per se a winning strategy, we believe. Instead, we think it could be opportune to move money out of vulnerable individual stocks, and put it towards less vulnerable, more insulated individual stocks. We will look at a couple of examples.
Airlines, Cruise lines, Hospitality Are Vulnerable Industries
With new cases rising, authorities have already begun to impose new restrictions on travelers. New York, New Jersey, and Connecticut will impose inbound quarantine measures on travelers from states such as Florida. At the same time, international travel is also experiencing headwinds, showcased by the fact that the EU may ban Americans from entering due to the reemergence of the virus. Airlines, which are dependent on an ongoing recovery in national and international travel, may thus experience a way more complicated path to recovery, compared to what seemed possible 3 weeks ago.
Stocks of airlines (JETS) such as Southwest (LUV), American (AAL), Delta (DAL), and United (UAL) have risen substantially from the lows, although they have given back some of their gains already. Boeing (BA), which is highly dependent on commercial aircraft sales, is up by more than 35% from early April as well. It seems quite possible that even more of the gains from early June will be given back over the coming weeks, which is why holding airline stocks could be risky due to the reemergence of the virus.
Brick-and-mortar focused retailers could be vulnerable as well. This is especially true for retailers in malls that sell products that are easily bought online, which includes companies such as Macy’s (M) and Kohl’s (KSS). Even if there is no direct lockdown, consumers may still choose to not shop in these rather dense environments, instead opting to purchase clothes, perfumes, etc. online. Not all brick-and-mortar retailers will be impacted in a similar manner, however, companies such as Lowe’s (LOW) and Home Depot (HD) have done well during the first wave, and may do well during a second wave, too.
We are not bearish on oil stocks overall, as scrapped growth projects will result in higher oil prices a couple of years down the road (this is what we believe, at least). In the near term, however, oil stocks may trade on short-term movements in oil prices, and on near-term expectations for oil demand, thus it seems possible that the oil industry (XLE) could be subject to declining share prices if new cases continue to climb.
Resilient Stocks That Could Help Prepare Your Portfolio
Not all companies will be impacted by the “second wave” in the same way, some companies will see no meaningful impact, while others may actually benefit. Moving to these lower-risk stocks could help improve the resilience of a portfolio. Ideas of companies that will likely not be impacted too much by the ongoing resurgence of the pandemic include, among others, healthcare-related stocks.
Biotech companies such as AbbVie (ABBV), Bristol-Myers Squibb (BMY), or Gilead Sciences (GILD) will likely not see demand for their products decline meaningfully. In Gilead’s case, the company’s drug remdesivir that can be used as a COVID-19 treatment could even result in an improving revenue outlook if coronavirus cases continue to climb, as this would likely result in more people receiving treatment. Another healthcare stock that may be a good place to move to is Johnson & Johnson (JNJ), thanks to its very diversified business across drugs, medtech, and staple consumer goods. The company holds a AAA rating on top of that, making it one of the stocks with the lowest financial risk overall. Pharma companies that are engaged in finding a vaccine for the coronavirus could also help make a portfolio resilient, especially when these companies possess large, diversified revenue streams, which is true for Pfizer (PFE), Merck (MRK), etc. Pharmacy companies are another sector that could continue to do well during the second wave of the pandemic, which makes CVS Health (CVS) and Walgreens Boots Alliance (WBA) worthy of a closer look.
Both the essential retail industry as well as tech mega-corps seem to be resilient versus the pandemic, as they did not suffer from large negative impacts during the first wave. It seems reasonable that they will be resilient during a second wave, too. This includes companies such as Amazon and Microsoft, but also Walmart (WMT), Target (TGT), and Costco (COST). Valuations matter, however, and we believe that at least some of these stocks may be too expensive to warrant a buy right here:
These five stocks trade at 24 – 136 times this year’s profits, which means that future returns may not be overly high, even though these companies are resilient and more or less immune to the current crisis.
Unfortunately, it looks like the trend of declining COVID-19 infections has ended in the US. Newly diagnosed cases keep climbing, and increased testing cannot fully explain this, so it has to be assumed that the disease is spreading once again. Fortunately, the most vulnerable seem to be less impacted compared to the first wave in March and April, as senior housing facilities and individuals are better prepared.
The Fed’s printing of trillions of dollars, combined with the fact that a country-wide lockdown seems unlikely, means that we will likely not see a violent market-wide selloff like the one from March. Equity investors should still take a closer look at their portfolios and think about what a second wave of the coronavirus pandemic means for each individual stock. Moving towards more resilient companies, and out of more exposed stocks such as airlines or cruise lines, seems to be an opportune choice.
One Last Word
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Disclosure: I am/we are long ABBV, BMY, JNJ. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Originally published on Seeking Alpha