Written by Jim Welsh
Macro Tides Weekly Technical Review 20 April 2020
The S&P 500 rallied 2.68% on Friday April 17 after receiving a trifecta of good news. On Thursday afternoon it was reported that Gilead’s drug remdesivir had proved effective in treating patients with a severe case of COVID-19 in a Phase 3 trial. Of the 125 people treated 113 patients had been released from the hospital and only 2 died.
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The market was also given a lift after Boeing announced on April 17 it would bring 27,000 workers back in the state of Washington to restart commercial aircraft production. Boeing’s stock soared $19.00 and added 133 points to the DJIA’s gain of 704 points. The market’s reaction to the Boeing announcement is interesting given that passenger traffic is down 95% from a year ago and a number of major airlines have slashed their May flight schedules by 90%. The third push came as President Trump said after the market closed that he would provide the guidelines for reopening the economy.
While the concept of reopening the economy is embraced by almost everyone, the devil is in the details and in this case there are a lot of missing details. There are 3 broad problems that will slow the process:
- The volume of diagnostic testing has improved, but still lags behind what most public health experts say will be needed to keep the virus controlled.
- The volume of testing has to increase from 150,000 a day to closer to 5,000,000 or more by June, so any outbreak can be identified immediately and controlled. With up to 40% of those infected asymptomatic, but capable of spreading the disease for up to 14 days, the only way any spread can be contained is through widespread testing.
- The ability to perform contact tracing has to be expanded significantly so community spread can be contained, once someone has tested positive. Currently, only a few states are recruiting and training the army of public health workers who will be needed to track, trace, and isolate anyone exposed to the coronavirus.
As discussed in the April 13 WTR, Singapore rolled out a smart phone app called Trace Together on March 20. The app enables Phones within two meters of each other to exchange Bluetooth signals, allowing the app to make a record of the encounter. When a patient doesn’t have the contact details of a person they came into contact with, or simply can’t remember an encounter from the two weeks prior to their infection, the app is expected to provide medical personnel more complete data doing contact tracing. Apple and Google announced they are working together to produce software that can assist in contacting anyone who was with an infected person in the prior two weeks.
There are certainly a number of serious privacy issues that must be addressed, but this type of technology could prove indispensible in contact tracing.
Antibody testing is just beginning but the hype likely exceeds the potential benefit, and a broad application of using antibodies to fight COVID-19 is limited. The hope is that antibodies from a person who has recovered from COVID-19 can intravenously be given to an infected person, so the antibodies from the recovered person can jumpstart the production of antibodies and help infected people recover more quickly and lower the fatality rate.
Stanford University tested blood samples from 3,330 people in Santa Clara County, which has a population of 1,933,383, and found that only 3% of the population has or has had coronavirus. A study in the Netherlands of 7,000 blood donors also found that just 3% had antibodies. With so few people around the world with antibodies, using intravenous transfers of antibodies as an effective treatment option is quite limited.
In addition, the FDA chief has warned many of the antibodies testing kits currently available aren’t accurate. So there aren’t enough tests to find those who have antibodies and the tests being used aren’t up to standard.
The Guardian has summarized the problems of developing herd immunity from such a small infected base.
The R0 (R naught) value for any virus is an attempt to calculate how many people an infected person subsequently infects. If a virus has a R0 of 1.0 it means that each infected person will infect 1 other person. Any virus that has a R0 below 1.0 is far easier to control than a virus with a R0 above 1.0. COVID-19 has been estimated to have a R0 of 2.2, but a new study published in the Emerging Infectious Diseases journal, shifts the R0 for COVID-19 from about 2.2 to 5.7. While Gilead’s remdesivir is good news for those who become infected, it does nothing to prevent infections.
The R0 value has a direct correlation with herd immunity, which is the level an infectious disease will not spread. If enough people become immune to the disease, then it will stop spreading in the population. The best way to acquire immunity is through vaccination rather than having a large portion of a population becoming immunized from contracting the disease. If COVID-19 has a R0 of 2.2 roughly 55% of the population will need to become immunized, but 82% would have to have immunity if the R0 is 5.7. So far only 1% of the 330 million people in the U.S. have been tested, so there won’t be a more accurate estimate of COVID-19’s R0 value until far more testing is completed in coming months. The problem is keeping the economy shut down until that data is available is not a viable option. (For more on this problem, there is a good article in Forbes.)
As of April 20 there have been 792,076 cases of COVID-19 in the U.S. and 42,483 deaths, with approximately 3% of the population having acquired some level of immunity. Shutting down the economy and the implementation of social distancing is expected to cause the number of infections and deaths to peak in the next two weeks, before they actually decline. The models suggest the number of infections could approach zero for the U.S. sometime in June. (See charts below)
As the economy is reopened and more people come in contact with other people, the incidence of infection will increase from whatever trough is attained, as will hospitalizations, and ultimately the number of deaths. If the R0 is 2.2, and only 3% of the population has developed antibodies, an estimate / guestimate can be made of how many cases may develop before 55% of the population has had COVID-19 and acquired immunity to achieve herd immunity. The increase from 3% to 55% represents an 18.3 fold increase and would project total cases could reach 14,521,000. A commensurate increase in the number of deaths would suggest 777,400 people would die before herd immunity is achieved.
If the R0 is 5.7 and herd immunity must reach 82%, the number of cases would rise to 21,650,000 and 1,161,200 people would die.
These are hard numbers to accept.
As promised social distancing succeeded in flattening the curve as the majority of Americans adhered to the guidelines. COVID-19 infections and deaths have fallen well short of the dire modeling projections for the U.S. The total number of infections and deaths are still rising but it is clear we are nearing the peak.
Governors around the country are being pressured to open the economy in their states. Some governors will decide to open, even though the number of infectious cases has not been declining for at least two weeks. This seems like a prescription for potentially a large increase in infections and deaths in those states. The question governors and the country as a whole must answer is how many deaths are acceptable as the economy is reopened?
A recent survey shows the majority of Americans are more worried about opening too soon.
Economists have been debating whether the coming recovery will look like a V, U, or L. The plunge in economic statistics for March has convinced many that a V-shaped recovery may be too optimistic. Conversely, the swift and monumental monetary actions taken by the Federal Reserve and $2.3 trillion CARES ACT passed by Congress has led others to conclude that an L-shaped recovery is too pessimistic.
By default most economists now believe the recovery will look like a U but that too may prove too optimistic. My bet is the recovery will not be a V, L, or U, but will reflect a modest bounce from a low point around mid-year, and then an extended period of gradual improvement that is likely to take longer and be less vigorous.
The reality is life as we knew it at the end of 2019 is not coming back for a long time. Until there is a vaccine, the risk of another outbreak will keep social distancing in place which will result in fewer people being allowed to frequent public spaces. Older Americans will likely be advised to be careful and not venture out much, so their spending levels will be less. Many Americans have acquired new habits while sheltering in place and some of those new habits will mean more reliance on the internet for shopping.
Companies will learn they can get along with fewer employees after implementing the technology allowing more of their workers to work from home. Companies won’t need as much office space which will hurt commercial real estate firms. The stock market has priced in a V-shaped recovery so disappointment in the pace of the recovery is expected to cause a retracement of a good portion of the gains since the low of 2192 on March 23.
We’ll soon know whether those concerns are justified or not.
Stocks
In the February 10 WTR entitled “The Last Stocks Standing” I noted how just a few stocks were carrying the S&P 500 higher.:
“As the S&P 500 was making a new high on February 6, 227 stocks in the S&P 500 were actually down year to date. The mega cap stocks (Microsoft, Apple, Amazon, Facebook, and Alphabet Class A&C) comprised 18.1% of the S&P 500 as of February 7 and have enabled the S&P 500 to make a new high. As long as these 5 stocks continue to attract money from momentum investors, the S&P 500 can make marginal new highs and help the overall market hold up.”
The rally from the March 23 low has been led by the same stocks since they are not only expected to survive whatever comes but will actually thrive if the economy is slow to rebound. The concentration of these 5 stocks has become even more pronounced. These 5 stocks have been joined by a few more essential stocks like Netflix, Johnson & Johnson, Campbell Soup, Domino’s Pizza, Abbot Labs, and biotechnology stocks.
As discussed in the April 6 WTR, the S&P 500 was expected to rally to 2792 and potentially up to 2896:
“From the low of 2192 the S&P 500 rallied to a high of 2641 on March 31 a gain of 449 points, which appears to be Wave A. The quick sharp drop to 2447 on April 1 was likely Wave B. The rally since the low of 2447 is the beginning of what should be Wave C. If Wave C is equal to Wave A, the S&P 500 would move up to 2896. The other two primary targets are the 50% retracement of the plunge from 3393 to 2192 which is 2792 and the 61.8% retracement target of 2934.”
The S&P 500 traded up to 2879 on Friday April 17 after the Gilead Science news and Boeing’s announcement.
There were more stocks down than up on April 13, 15, 16, and 20 but on each of those down days traders bought more Calls than Puts. Buying more call options on days market prices fall is an indication that investors have high expectations for the market. This shift in sentiment is evident in the Option Premium Ratio which has plunged during the rebound after spiking higher in March.
The stock market will be balancing two opposing forces in coming days and weeks. On one hand investors are bullish due to the actions by the Federal Reserve and Congress, but must also appraise how the economy will perform and whether their expectations are too optimistic. The perception is that the Federal Reserve and Congress have created a record amount of stimulus which is why so many are so sure the economy is going to experience a U-shaped recovery.
The Fed acted to restore functionality and stability in a number of financial markets and Congress passed a safety net package so millions of formerly working Americans can remain in their apartment or home and put food on the table.
What policy makers have done is to take steps to avoid a depression, which hardly counts as a stimulus program considering the circumstances. The best stimulus package possible is a vaccine. Once the health crisis passes and workers and consumers can resume some semblance of normality, Congress will pass another package that will put more more into the economy and that will act as stimulus.
My expectation is that the economy will remain weak which will increase pressure on governors to open their economies. If infections increase as the science indicates is likely, investors will have to reassess their outlook and earnings estimates for the second half of 2020. If any states have to roll back their attempts to open their economy, the stock market could retest the March low.
If the recovery simply proves weaker and the recovery takes longer, the S&P 500 can easily fall to 2650 – 2700.
If the S&P 500 climbs above 2879 traders can take a 25% short position in the S&P 500 using a stop of 2950 on a closing basis.
Treasury Bonds
I thought the 10-year Treasury yield would drift higher to 0.90% – 1.05% as the stock market rallied to the target of 2896 on the S&P 500. Despite the rally in the S&P 500, economic data has been so weak Treasury yields have chopped sideways. If the stock market reverses lower and infections increase as sections of the economy are opened, the 10-year Treasury yield has been expected to eventually fall to the near the lows of March 9.
The 30-year Treasury yield is likely to fall under 1.0% and could approach the March low.
Gold
Bullish sentiment toward Gold has zoomed as investors perceive the actions taken by the Federal Reserve as bullish for Gold irrespective of the hard evidence of deflation. Oil prices have collapsed, consumer spending has plunged, and the unemployment rate is headed for 15%. Excess capacity is everywhere and the slack in the labor market isn’t going away just because the Fed cut rates and Congress passed a $2.3 trillion spending bill.
To the extent that Gold has rallied on the belief inflation is coming, those investors may have a long wait. With the increase in bullish sentiment, positioning in Gold has become extreme with too many investors already long. The trend line connecting the highs in August 2019, and February and March is expected to contain Gold and lead to a drop below $1600.
Gold Stocks
The expectation last week was that GDX ‘will test $31.84 and probably make a modest new high.’ On April 14 GDX traded up to $32.27 before reversing lower. The financial markets may be setting up a mini replay of March. The stock market, Gold, Gold stocks all fell, while Treasury bonds and the Dollar rallied.
If Gold drops under $1600, GDX can drop to $27.00 or lower with a possible fall to $24.00.
Dollar
Currency traders have become more bearish the Dollar after the Federal Reserve moved so aggressively to ease interest rates and flood the financial system with Dollars in the U.S. and foreign currency market to ease the Dollar shortage. Bearish bets against the Dollar have increased and are nearing the levels in August 2017.
This increases the potential that the Dollar will rally above 101.0 and exceed the January 2017 high of 103.82. If the attempts to open the U.S. and other economies around the world sputter and some countries are forced to retrench, the Dollar would rally on another flight to quality.
Emerging Market
If countries struggle to reopen their economies, another wave of selling could swamp the global equity markets.EEM was expected to rally a bit more if the S&P 500 rallied above 2800. EEM is expected to trade down to $30.10, which was the intra-day low on March 23. This would complete its Wave 5 decline from the high of 46.32, and set up a great buying opportunity.
Tactical U.S. Sector Rotation Model Portfolio: Relative Strength Ranking
As noted last week, a cross above the red moving average by the MTI would generate a bear market rally buy signal, which occurred on April 16. If the past is any guide it may prove to be a whip saw trade as the table below illustrates. It is common after a large decline for the first crossover buy signal to be followed by a retracement that is deep enough to cause the MTI to cross back below the moving average. In the current environment this outcome seems likely, unless the R0 level for COVID-19 is far lower than 2.2 and the U.S. is able to reopen without a meaningful increase in infections.
A crossover below the moving average is considered a sell signal. The expectation is that the S&P 500 will decline enough to cause the MTI to fall below the red moving average, even if a full retest of the March 23 low does not develop. Since 1962 the smallest whip saw loss was -4.0% and the average was – 7.9%. In 1987 there was only a single crossover, but there was also a full retest of the initial low prior to the bear market rally buy signal.
Disclosure
The S&P 500 Index is a broad-based measurement of changes in stock market conditions based on the average performance of 500 widely held common stocks. The Russell 2000 Index is a small-cap stock market index of the bottom 2,000 stocks in the Russell 3000 Index. The Nasdaq 100 is composed of the 100 largest, most actively traded U.S. companies listed on the Nasdaq stock exchange. All indices, S&P 500, Russell 2000, and Nasdaq 100, are unmanaged and investors cannot invest directly into an index.
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