The Variants and the Vaccines
The week ahead will be a quiet one for economic data and a busy one for corporate earnings. It could also be a pivotal one in Washington as the Biden Administration tries to advance its agenda in Congress. However, for investors, the pandemic may once again demand attention, with the sudden dominance of the highly contagious Delta variant rattling markets. In this regard, it is important to recognize that vaccines continue to be very effective against the virus and this fact, combined with high vaccination levels among the elderly, should limit fatalities from the latest wave. This, in turn, should allow for a continued reopening of the economy, along with an eventual rise in interest rates from very low levels and a consequent restarting of the rotation from growth to value stocks which has stalled in recent months.
On the economic front, housing will be in focus. We expect modest gains in housing starts, following some weaker numbers in recent months, and a relatively flat pace of existing home sales. However, investors may pay most attention to home prices which have soared in recent months and could, over time, feed indirectly into higher consumer inflation. Thursday’s unemployment claims data should provide further clarity on labor market momentum following the expiration of enhanced unemployment benefits in about half the states. In addition, flash PMI data, due out on Friday, should provide some guidance on the impact of a renewed surge in Covid-19 cases on the global recovery.
79 S&P500 companies are set to release their second quarter earnings this week. The earnings season is proving to be extremely strong, with 80% of companies so far beating analyst expectations on earnings and 83% beating on revenue. Year-over-year EPS growth numbers are obviously distorted by the economic shutdown in the second quarter of 2020. However, our estimate of last quarter’s earnings, calculated as a blend of already-reported numbers and analyst estimates is now $46.19 which would be the second highest quarterly number ever, trailing only the first quarter of this year. While earnings headwinds will likely increase in the year ahead, this higher level of earnings will likely lead analysts to upgrade their forecasts for 2022, reducing recently very high forward P/E ratios.
The week ahead could also be a critical one for President Biden’s legislative agenda. While the Administration and a bipartisan group of moderate Democratic and Republican senators have agreed on spending in an infrastructure plan, they remain divided on how to fund it with proposals to use tougher IRS enforcement as a revenue raiser apparently now dropped from the bill. In theory, if funding can be agreed, then the bipartisan infrastructure bill and the Democrat-only omnibus reconciliation bill could get initial approval this week. The combined impact of both bills would likely amount to significant fiscal stimulus going into 2022. However, getting them both through Congress is a delicate minuet in a very divided political environment, so the odds on decisive action on both bills this week remain relatively low.
Overshadowing all of this for markets, however, will likely be a rise in Covid-19 cases. After falling during the late winter and stalling at a low level over the spring, the pandemic is showing signs of resurgence, with confirmed cases climbing from a seven-day moving average of 12,500 at the end of June to almost 32,000 yesterday. Remarkably, all 50 U.S. states have seen an increase in cases over the last two weeks. The reason for the surge is likely the rapid spread of the Delta variant which, according to the CDC, rose from 10% of U.S. cases in the two weeks ended on June 5th to almost 58% of cases in the two weeks ended on July 3rd.
The fact that case counts are rising in even the most vaccinated states, (albeit from much lower levels), provides further evidence of just how contagious this variant is and suggests that the next few weeks could see further increases both in total cases and fatalities.
However, it should be recognized that current vaccines do appear to be very effective at preventing severe illness from even the Delta variant. Studies from the UK suggest that while the Delta variant is causing more “breakthrough cases”, fully vaccinated people have a roughly 96% lower probability of being hospitalized from the Delta variant compared to unvaccinated people.1 These statistics confirm other observations by the CDC and private organizations that close to 99% of recent fatalities and hospitalizations for Covid-19 are among unvaccinated people.
It should also be noted that while less than 49% of the U.S. population is now fully vaccinated, this percentage rises to 79.5% for the population over the age of 65 who accounted for over 80% of coronavirus fatalities last year.
These realities will likely prove very important in assessing the impact of this new pandemic wave on the U.S. economy. On average, 281 Americans lost their lives to the disease every day last week, which is a pace equivalent to over 100,000 people in a year. However, for adults who are fully vaccinated and are not immune compromised or for children whose immune systems seem to do a better job in fighting off the disease, the threat of the virus is likely not enough for them to put their lives on hold any longer.
Because of this, while the pandemic will demand increased attention over the weeks ahead, the general transition to a reopened economy will likely continue. This, in turn, should lead to further gains in output and employment, stubbornly high inflation and strong corporate profits. It should also keep the Federal Reserve on track to begin to taper bond purchases at the end of the year, allowing interest rates to finally move up from current extraordinarily low levels, hurting long-duration bonds and restarting a rotation from growth stocks to more cyclical value sectors.