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We’re all virologists now, right?
Well, maybe just enough to be dangerous, as the saying goes.
While investors have driven a rally in the Dow Jones Industrial Average DJIA, +1.90%, S&P 500 Index SPX, +1.68% and Nasdaq Composite Index COMP, +1.57% since the late-March lows, it’s ominous that people who know a lot more about science than the rest of us are scratching their heads about the optimism.
They caution the coronavirus pandemic is nowhere near over, and it’ll come back with a vengeance after any summer lull. If they’re right, the current market rally is suspect because that’ll be bad for the economy. It’s particularly noteworthy that many of the skeptics come from the normally buoyant and bullish sell-side analyst community.
Take Morgan Stanley biotech analyst Matthew Harrison.
“While we understand the desire for optimism, we also caution that the U.S. outbreak is far from over,” he says. “Recovering from the acute period in the outbreak is just the beginning and not the end.”
Harrison cautions the end won’t arrive until a vaccine is available, in spring 2021 at the earliest.
“We stress that only a vaccine will provide a true solution to this pandemic,” he says.
Reopening the economy, which began in some states late last week, will be a long and drawn-out affair that involves turning various forms of social distancing on and off in a trial-and-error period, he says. Many employees won’t be able to go back to work during this phase.
And large venues including sports arenas, concert halls and theme parks will stay shut, or have attendance capped. Economists at Morgan Stanley predict the economy won’t return to pre-COVID-19 levels until the fourth quart of 2021. No V-shaped recovery — a quick down-and-up — in their forecast, in other words.
Next flu season
Virologist Michael Mina, a medical doctor and assistant professor of epidemiology at Harvard University, cautions that the COVID-19 could easily come back with a vengeance next flu season, possibly causing another shut down of the economy. It could spread even faster.
The reason is there will be thousands of cases smoldering throughout the country that could serve as starting points for the spread, as opposed to a much smaller number from the get-go last winter.
“We could see very rapid transmission, even faster than the first time,” he says.
Jefferies biotech analyst Michael Yee is also cautious.
“We understand that the market wants to embrace the light at the end of the tunnel, but it is probably not that simple,” he says.
He says we need to see a lot more progress on therapies and vaccines before we can fully open up the economy and ease off social distancing.
No silver bullet
There’s been optimism about Gilead’s GILD, -0.15% remdesivir antiviral fixing the issue. The U.S. Food and Drug Administration (FDA) has given emergency-use authorization for remdesivir to treat COVID-19, based on results from a National Institute of Allergy and Infectious Diseases study.
The biotech experts I spoke with aren’t convinced this will be much of a solution.
“Remdesivir doesn’t look exceptionally effective,” says Baird analyst Brian Skorney. “We remain skeptical of the magnitude of benefit.”
He’s also cautious about the current plan to unlock the country on a regional basis. He thinks this is “very dangerous,” given how much travel there is among states, and the low number of people who might have immunity because they’ve been infected.
“If current social-distancing protocols are relaxed too early, we could easily see a substantial second wave of COVID-19 disease,” Skorney says.
Federal Reserve vs. COVID-19
One could argue that the caution in the science community is unwarranted because it doesn’t fully understand the meaning of “don’t fight the Fed.” The Federal Reserve has unleashed enormous stimulus in response to the economic damage caused by the lockdown, and that kind of action normally prevails, according to this dictum.
But even the Fed sides with the cautious virus experts and biotech analysts. Because of uncertainty about how the virus will evolve, the pandemic poses “considerable risks” to the economy, the Fed noted April 29. Fed Chairman Jerome Powell also worries about possible damage to production capacity due to a potential wave of bankruptcies among smaller companies, and extended unemployment. People begin to lose their skills and work habits when they stay unemployed for too long.
Market technicians also have concerns. One of the hallmarks of the early stages of a bull market is that leadership is reasonably broad, and particularly prevalent among small-cap stocks, points out Baird chief investment strategist Bruce Bittles.
In contrast, the rally off the late-March lows has been driven mainly by Facebook FB, +0.51%, Amazon AMZN, +0.50%, Apple AAPL, +2.38%, Netflix NFLX, -0.22%, Alphabet GOOG, +1.15% GOOGL, +1.10% and health-care stocks. (The iShares NASDAQ Biotechnology Index exchange traded fund IBB, +0.97% is up for the year.)
“A sustainable advance requires participation from a broad group of sectors and individual stocks,” says Bittles.
He also points out the S&P 500 recently traded near 19 times expected 12-month earnings. That already looks pricey, he says, because it is above the 10-year average, and it is higher than the valuation at the stock market’s mid-February peak.
But valuations could get much worse because analysts aren’t done cutting their estimates. The more they cut, the higher the market valuation goes, even if stocks just stand still.
“Historically, stocks generally do not go up during periods of declining earnings. Our economy will recover but expectations may have gotten ahead of tangible data,” he says.
The good news
A least there’s a good chance the stock market won’t retest the late-March lows. Aside from Fed support of investor sentiment, there’s a big pile of cash waiting to be deployed. After a lot of investors raised cash in March, the bargains did not last long enough for redeployment because the Fed and other central banks responded with such fast and forceful action.
“They poured so much liquidity into the financial markets, many of the fire sales were rapidly extinguished,” says Ed Yardeni of Yardeni Research. “Now many investors who cashed out are sitting on a mountain of cash. That suggests that any significant selloff in the bond and stock markets might be limited, as those who had dashed for cash now seek opportunities to rebalance back into bonds and stocks.”
At the time of publication, Michael Brush had no positions in any stocks mentioned in this column. Brush has suggested FB, AMZN, AAPL, NFLX, GOOGL, IBB and XBI in his stock newsletter, Brush Up on Stocks. Brush is a Manhattan-based financial writer who attended Columbia Business School. Follow him @mbrushstocks.
