Summary
– COVID-19 case trends have deteriorated as the Delta variant rises proportionally to existing strains.
– Our central case is now that 10-15 states (those with lowest vaccination rates) will see another parabolic rise in cases in the next few weeks.
– Importantly, we do not see a high likelihood of lockdowns in response to these elevated levels of infection as adverse outcomes will likely fall significantly as a portion of cases. Surge in vaccinations likely.
– Our strategy and favorites remain the same. Epicenter is solid, Energy is our favorite sector and we think FAANG recovers in July and should do well in spite of the transitory headwinds we anticipate.
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So far, US COVID-19 cases are not following the parabolic surge seen in the UK. Case trends are rising linearly, but for those states with lower rates of vaccination, we expect a parabolic rise and this is now our central case.
However, we do not necessarily anticipate the usual corresponding adverse outcomes like hospitalizations and deaths. The positivity rate is now 2.2% and rising. It had fallen below 2% for many weeks but it is again curling upwards.
Importantly, we are not panicking here. The vaccination rates are higher in the US than many places in the world and the penetration of the mRNA vaccines are particularly high. Curiously, the UK is the only European nation with a surge.
I am not sure why the delta variant is spreading so rapidly in the UK but not throughout Europe. This could be a matter of timing and Germany, France and the rest of the continent are about to see a surge in cases associated with the delta variant. We are continuing to monitor this closely.
Tireless Ken found this chart. The darker the color, the greater the share of the Delta variant. And as you can see, the delta variant is in Europe, but the share is small. My guess is that the delta variant will likely cause a surge in nations with low vaccination (and particularly low mRNA vaccinations) rates.
The latest COVID-19 daily cases came in at 12,782 up +1,789 (ex. FL & NE) vs. 7D ago. The number of daily new cases has been creeping up. The 7D delta has been positive for 8 of the last 9 days. Although the speed of the case increase is still linear (not parabolic like UK), the Delta variant is proving to be a significant obstacle toward eliminating COVID-19 from the US.
As we noted previously, the vaccination penetration appears to have some causal relationship with the case trend as the case figures are rising most in the states with relatively lower vaccination rates. Hence, if the case figure truly starts to surge rapidly, we expect policymakers to make a renewed push for vaccination instead of introducing economically devastating lockdowns.
STRATEGY: FAANG Likely Strengthens In July, Epicenter Still Solid. Energy Still Our Favorite Sector
As we look forward into 2H2021 and July 2021, we remain favorable toward Epicenter stocks. I realize these got hit hard in mid-June and have since slowly recovered. In a way, this is reminiscent of the beating FAANG took in early 2021. After stabilizing it recovered its footing and we think the same will likely happen now. We wanted to summarize our views on our overweight sectors.
FAANG (FNGS, MAFANG, FNGU) is ready for a breakout in our opinion. The transitory panic around COVID-19 strains will likely help FAANG as virus concerns result in the ‘flight to safety.’ Communications Services (XLC) will also likely be a beneficiary of any panic associated with the Delta variant.
As far as Epicenter goes, Energy is our favorite sector and the massive FCF generation and the CAPEX shortfall are powerful bullish drivers. Materials also has great FCF generation which is a positive pressure on price. There have been above-consensus expectations readings for industrial demand in reading after reading and this is obviously very positive for Industrials. The Discretionary sector is very well situated when you consider that this sector houses many industries that will be major beneficiaries of the “revenge spending” phenomenon we anticipate on an unprecedented scale.
In other words, we still see positive factors supporting our Overweight sectors. We see the equity markets in July broadening, so there should be wide participation on the way to the S&P 500 reaching approximately 4,400. We then expect a pullback and recovery to 4,600 by YE2021.
We believe there is a fundamental reason for FAANG remaining amongst the strongest performers in the S&P 500, both in topline growth and in profit margins. But the headwinds seen in stocks in early 2021 were a function of rising rates, FAANG being crowded, and other sectors seeing the type of growth FAANG was known for. This phenomenon was explored by us when we did analysis on post-war Economies and Cyclicals becoming the highest growth stocks in such an environment.
As rates have cooled and as FAANG valuations declined from their stratospheric levels we see a particularly strong risk/reward tradeoff in these stocks. Afterall, if the S&P 500 is +25% in 2021 so far and APPL and AMZN are up 3.5% and 5.4% respectively then the implied upside would be 20% or more for these massive stocks that will affect the indexes positively.
BOTTOM LINE: Strong Markets Stay Strong but July May Be Choppy
Going forward into the second half of 2021 (2H) we see very strong gains. We think leadership from this rally is both Epicenter and FAANG. We see complex July headwinds, but also many positive drivers.
Energy remains our favorite sector because of the positive supply/demand dynamics in oil. FAANG benefits from “undershoot” of interest rates relative to consensus. We like Epicenter broadly and think data will be favorable this week.
Figure: Way forward ➜ What changes after COVID-19
Per FSInsight
Figure: FSInsight Portfolio Strategy Summary – Relative to S&P 500
** Performance is calculated since strategy introduction, 1/10/2019
