People in vehicles wait in line to enter a drive-thru Covid-19 testing site in a parking lot of Miller Park in Milwaukee, Wisconsin, U.S. on Monday, Nov. 9, 2020.
Bing Guan/BloombergInvestors haven’t cared all that much that lockdowns may re-emerge, because there’s enough cash flowing through the economy to keep the environment stable. Perhaps they should be more worried.
Since Oct. 28, the S&P 500 is up 7.7% in a broad-market rally. With Joe Biden now the president-elect, some uncertainty has been removed. A likely divided Congress means fewer drastic changes in industrial policy. Economic data and earnings have been strong—and better than expected—lifting earnings expectations for the next year. The likelihood that Covid-19 vaccines are approved this year has drastically increased.
But there’s a roadblock to the continued economic and earnings recovery. Not only have new daily Covid cases in the U.S. hit a new high of 140,000, according to Johns Hopkins University, but one of Biden’s coronavirus advisors, Dr. Michael Osterholm, said widespread lockdowns may be necessary soon and recommended a four-to-six-week shutdown.
To be sure, the market is reacting Thursday, with the S&P 500 down 1.3% in recent trading and reopening-sensitive stocks down—Wynn Resorts (WYNN) was down 5.5%, for example.
“The market is in a tug of war between the most difficult period in terms of cases and some time in 2021 we’re going to have a vaccine,” said Marc Pfeffer, chief investment officer at CLS Investments. But the risk-off move in markets Thursday has been fairly muted. “We’ve already lived through the initial reaction to the virus in March, and a big part of the reason the markets crashed is the uncertainty,” said Matt Orton, portfolio specialist at Carillon Tower Advisers. “No one knew how long the economy was going to be shut down for. Now, there’s a lot more that’s known.”
Part of that certainty is people are aware that lockdowns may not last so long, whereas in March, the duration was anybody’s guess. Also, the Federal Reserve took a few weeks to announce that it would essentially provide unlimited monetary stimulus. This time around, investors know the Fed is purchasing billions of dollars of corporate bonds a week, keeping rates low.
In March, U.S. high-yield credit spreads hit 11%, choking off corporations’ ability to borrow and restore liquidity. Now, spreads are holding still at around 4.3%, according to St. Louis Fed data. That’s not far above the 4% level seen in the months leading into the pandemic, which means companies have access to capital and should be able to weather any storm upcoming.
Still, lockdowns would cause more layoffs and furloughs, and near-term revenue for lockdown-sensitive companies would take a hit. One problem: Fiscal stimulus keeps getting delayed. In the event of lockdowns, that means households and small businesses won’t secure the liquidity they did earlier in the year. Preffer argues that the White House transition is yet another roadblock to stimulus measures that would be needed this winter, when the lockdowns would likely occur.
Another issue: Treasury yields have been rising, with the 10-year yield up to 0.91% from 0.76% on Nov. 4. The economic momentum has justified this, but not if lockdowns are reimplemented. Orton points out that the October inflation read of 0% shows that—aside from the negative valuation impact of rising rates—the economy likely couldn’t handle a rise in the 10-year yield to around 1.2%. The would burden the cost of borrowing too much.
There is risk to near-term earnings for reopening-sensitive and cyclical stocks, but that risk is likely to be far more contained than it was when the virus broke out.
Email: jacob.sonenshine@barrons.com
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