fter a powerful rally off March lows, equity markets have recently encountered renewed volatility due to fears of a “second wave” in COVID-19 infections. We do not believe that a second wave of infections is taking hold. Rather, we believe that the suburban and rural parts of the US that largely escaped COVID-19 these past few months are now enduring their first wave of infections.
As shown on the map below, early hotspots for the virus like New York City and New Jersey are no longer the primary source of new infections. In addition, major metropolitan areas like Los Angeles, Chicago, and Miami are not seeing significant growth in active COVID-19 cases. A few mid-sized cities like Austin and Nashville are seeing accelerating infection rates, but the primary source of new cases appears to be rural and suburban areas.
These locales typically had low infection rates during April and most of May. The lack of an obvious pandemic threat may have encouraged members of these communities to disregard mask wearing and social distancing recommendations, especially during post quarantine Memorial Day celebrations. Spring planting and harvesting activities likely increased exposure risks among rural agricultural workers as well.
Total COVID-19 infection rates in the US remain stuck at about 20,000 new cases per day (see the chart below). The pandemic’s spread to suburban and rural areas is offsetting improvement in major metropolitan areas that were the early source of most COVID-19 cases.
This distinction between COVID-19 infection rates in major metropolitan versus suburban/rural areas has important implications for economic growth prospects and investment strategy.
Specifically, we believe that as COVID-19 moves to the suburbs its human cost may remain high, but its economic costs could decline. In that scenario, we believe that downside risk for the S&P 500 could be limited to dropping back into a 2750 to 3000 trading. Once a vaccine has been deployed, equity markets should be poised to break out to new highs.
The pandemic’s transition to suburban and rural areas may result in higher mortality rates for these communities. Suburban and rural areas tend to have older populations than urban locales, and vulnerability to COVID-19 tends to increase with age.
Also, rural communities have seen waves of hospital closures over the past decade. Local health care facilities may lack critical care infrastructure to fight the virus. These challenges may be partially offset by the fact that the virus may spread slower in suburban and rural communities. These residents are not as dependent upon commuter trains, elevators, crowded sidewalks, and other places where COVID-19 can easily spread.
Despite the potential human costs, the economic costs of the pandemic could continue to decline as we move through the summer and into the fall. Shelter at home requirements have been lifted in most locales, and politicians have little appetite for another broad based closure of the US economy. New measures aimed at containing COVID-19 are likely to be more narrowly targeted toward high risk populations and locales. About 90% of US economic growth comes from relatively large metropolitan areas.
If COVID-19 infection rates continue to fall in most cities, and we think they will, then US cities can remain open for business. That should allow US economic growth to recover despite accelerating infection rates in suburban and rural America.
One reason we think many cities could see a continued decline in infection rates is as simple as wearing a mask. A Texas A&M University study published on June 12th found that “not wearing a face mask dramatically increases a person’s chance of being infected by the COVID-19 virus.”
Mask wearing appears to be far more prevalent in US metropolitan areas than in rural ones due both to social and regulatory pressure. For example, all 15 of California’s most populous counties require masks in public, while none of California’s less populated rural counties do. Even participants in protests over police violence have largely adhered to mask wearing recommendations.
Masks, combined with selective quarantining of just those locales suffering from escalating infection rates, could slow the spread of COVID-19. Slowing the spread of new cases buys time for a vaccine to be deployed before a second wave of infections can occur. We believe that such strategies can eliminate the need for another sweeping shut down of the US economy.
US consumers are like coiled springs. We are eager to get out of our houses and spend some of the money we have been saving during the quarantine. Retailers and automobile dealerships are seeing a frenzy of buying. Once this pent up demand is exhausted, we believe the US housing market will provide a more sustainable engine for economic recovery.
As shown in the chart below, mortgage applications for home purchases are back to pre-crises levels. This jump in demand is prompted by the lowest mortgage rates in history and has occurred despite the highest unemployment rate since the Great Depression. As the unemployment falls housing demand should get even stronger.
Although demand is strong, supply remains depressed. Construction of new homes has been held back by quarantine restrictions. Builders will require several months to catch up on their backlog of unfinished homes.
Sellers have delayed listing existing houses for sale to avoid inviting strangers into their homes during a pandemic. The combination of strong demand and limited supply has accelerated price gains to 7.7% year over year as of 3/31/2020, according to the National Association of Realtors.
The Fed has pumped about $3.5 trillion of newly printed dollars into the US economy. As we have discussed in previous reports, all this liquidity combined with restricted housing supply could fuel another bubble in home prices. Strong price appreciation should continue to drive robust construction and sales activity in all major housing markets, in our opinion.
In our May 25th research report, we contended that for the market to keep moving higher, investors would have to be convinced that a vaccine would be ready before a second wave of COVID-19 infections could occur. We expected the S&P 500 to remain in a 2750 to 3000 trading range until September, when the first vaccines could potentially pass Phase 3 human testing.
Instead, the S&P quickly broke through 3000 and, despite recent volatility, could be poised to take out the old highs. This exuberant price action anticipates a high probability that a vaccine would be ready in time to prevent a second wave, in our opinion.
We do not think disappointing news regarding suburban and rural COVID-19 infection rates will derail the US economic recovery. We also think the odds are good that a vaccine will be ready by year end. As a result, we believe that downside risks for the S&P 500 are limited to a correction back into a 2750 to 3000 trading range (see the chart below). Such a market move, in our opinion, would be a healthy market correction.
Within that range we think valuations reflect an appropriate discount for the inevitable setbacks that typically occur in the economy and during the development of new vaccines. By contrast, we believe continuing to trade above 3000 anticipates an aggressively optimistic scenario for the economy and for vaccine deployment. At such lofty valuation levels, we believe investors should be prepared for unsettling market corrections such as occurred on June 11th whenever these optimistic expectations appear to be at risk.