The past few weeks have seen COVID-19 case growth accelerate in parts of the United States, with the total number of confirmed cases now well above 2.5 million. A handful of states – namely California, Arizona, Florida, Texas and Alabama – have been at the center of this most recent surge, and in some cases have paused, or even reversed, their reopening plans. While the fact that these new cases are increasingly concentrated in younger individuals may be a silver lining from a health perspective, interrupting the reopening process will prove to be a headwind for the economy more broadly.

We have spent a great deal of time discussing how the equity rally has been driven by case growth remaining contained, policy remaining accommodative and the reopening process going smoothly. From more of a technical standpoint, this rally was driven by rising valuations, as illustrated in the chart below. This valuation expansion has led to the best quarter for the S&P 500 since 4Q98, but it is important to remember that what valuations giveth, they can also taketh away.

With case growth accelerating and the future direction of fiscal policy uncertain, two of these pillars have been called into question. From a policy perspective, this makes it increasingly important that the unemployment benefits which are set to expire at the end of July are extended in the coming weeks. On the growth front, given that the direction of the data has been a more significant driver of markets than the level, the path forward for the economy will be monitored closely. However, we have far more information in hand than was the case three months ago; the risks to valuation are tilted to the downside, but a re-test of the March lows seem like a bit of a stretch.

The fundamentals are becoming increasingly important, and over the next few weeks, companies will begin reporting second quarter profits. The silver lining to the upcoming earnings season is companies may start to provide some guidance as to what they expect over the remainder of the year and into 2021. That said, we acknowledge that the distribution of outcomes remains wide, and maintain that the best investment approach will be one characterized by balance between quality and cyclicality.

Valuations and COVID-19 case growth

S&P 500 fwd. P/E and daily % change in 7-day moving average of new U.S. COVID-19 cases

Source: Bloomberg, FactSet, Standard & Poor’s, J.P. Morgan Asset Management.

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