Betting on a Vaccine


uring the early days of space exploration, the scientific community was uniformly opposed to a manned lunar mission. The consensus from scientists was that the cost of such an effort greatly exceeded the potential scientific benefits. However, the American people decided that we wanted to put a man on the moon and the Apollo program was born.

A similar consensus of medical professionals and infectious disease scientists are currently cautioning against prematurely lifting COVID-19 quarantine restrictions. However, the American people are growing tired of the economic and social costs of shelter-at-home orders.

Business are facing increasing financial pressure as Payroll Protection Program loan proceeds and other bailout measures are exhausted. Politicians recognize this growing impatience. As a result, much of the US economy will reopen over the next few weeks. Each state is opening at a different pace and under different social distancing requirements.

US infection rates appear to be on the decline, but have only dropped about 30% from peak infection rates (as seen on the chart below). By contrast, European countries like Italy (the second chart), Germany and France are reopening with infection rates having declined about 85 to 90% from recent peaks.

This big difference in infection rate declines suggests that, once social distancing requirements are relaxed, the US may face a higher risk of a renewed COVID-19 outbreak.

Risks of a second spike in infections is likely to grow as we move through the summer months and into the fall. Early indications are that many Americans want to enjoy the beach and other summer activities without worrying about masks or social distancing.

The heightened risk of a second spike in US infection rates means that US politicians and equity investors are making an implicit bet on a COVID-19 vaccine. US economic growth and a recovery in corporate earnings may depend upon a vaccine being ready soon enough that consumers and investors will look past any short-term flareups in infection rates.

This bet on a vaccine solution looks increasingly reasonable. The United States plans an unprecedented mass vaccine testing effort starting in July, with between 100,000 and 150,000 volunteer test subjects. Vaccine manufacturers have agreed to collaborate instead of compete and will share all clinical trial data. AstraZenica expects a September delivery for the first doses of its Oxford University vaccine, assuming it passes clinical trials.

This aggressive timetable is possible because the Serum Institute of India, the world’s largest vaccine manufacturer, is preparing 40 million doses before the vaccine has even been approved. Moderna and Harvard University have also announced rapid progress on their vaccine alternatives, and hope to have vaccines available by year end.

Assuming infection rates continue to decline, or a vaccine is approved, prospects looks good for a rapid recovery in several sectors of the economy. Mortgage purchase applications are back to 2019 peak levels despite shelter-at-home restrictions. Home prices are rising at a 10% annual rate. Search data suggest a coming wave of car purchases. Encouragingly, online reservation data for newly reopened cities indicate restaurants will see a rapid return of clientele.

By contrast, we do not believe the good news will extend to the aerospace and energy industries. Boeing has $80B of unsold airplanes in its inventory.

This is 10 times the inventory Boeing had going into the 2008-2009 recession. Boeing could theoretically meet a year’s worth of sales without producing another airplane. We do not believe that US fracked wells can compete with Saudi and Russian cost of production at $30 to $40 oil.

US rig counts are plummeting and jobs in the oil patch will likely fall along with drilling activity. A list of the top 10 US manufacturers is dominated by energy companies along with Boeing and GE, and GE is heavily exposed to both the energy industry and Boeing. In our opinion, jobs in these sectors could be depressed for an extended period.

Conclusion: Investment Outlook

Equity markets have pushed higher on a wave of Fed supplied liquidity. The Fed has purchased over $3 trillion in financial assets in recent weeks. This unprecedented liquidity injection creates a powerful tailwind for equity prices. Despite this tailwind, we expect significant additional market gains to be dependent upon the news flow.

Good news on economic reopening momentum or vaccine development could prompt a break above 3000 on the S&P 500, opening the door to retesting the old highs. Bad news could force a sudden retest of 2750. If COVID-19 infections spike high enough, equity markets could drop all the way to 2400.

Although we think such a severe correction is unlikely, we must acknowledge that most bear markets retest the lows at least once. Our expected outcome is for the S&P to remain in a 2750 to 3000 trading range until a vaccine emerges from Stage 2 trials (see the chart on the next page).

With the Fed on your side, we would use any pullbacks to add to equity positions. By contrast, vaccine deployment could prompt a sharp selloff in the bond market. We recommend investors shorten portfolio duration and underweight fixed income.

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