What Comes Next

The "What Comes Next" title is a reference to one of the songs sung by King George in Hamilton.  We can't quite put our finger on it, but it feels like there are certain parallels between Mad King George and our current situation.
What exactly is our current situation?  From an S&P 500 standpoint, we're back to where we were at the start of September.  These 11 weeks have been far from flat, though.  Down 10% over the first three weeks in September, then up 10% over three weeks into October, then down almost 8% in the three weeks leading up to the election, and then up 10% in what can only be described technically as a face-melting rally since the election.

To recap: pre-election, there were widespread expectations of a "blue wave", and the market sold off a bit because it didn't like seeing the specter of inflation in all the anticipated government spending that presumably Democratic Executive and Legislative branches would entail.  As election results came in and the blue wave never materialized, the market rallied.  A Deomcrat presidency with a Republican Senate probably means gridlock in DC and not much in the way of fiscal stimulus.  Thus, the burden of economic stimulus continues to fall to monetary policy and the ever-ready dovish accommodation of the Fed.  Moar QE, in short.  And as we have detailed previously and somewhat exhaustively, QE is good for stock prices.

Then Monday morning last week, Pfizer came out with a positive announcement on their vaccine's Phase 3 trial, and the market rips.  Small caps up 8%.  Airlines up 16%.  Cruise lines up 23%.  Movie Theaters up 60%.  Retail up 24%.  Even Hertz (still in bankruptcy, by the way) up 25%.  Face melting.

More broadly, you saw a statistically impossible reversal of prevailing trends on the vaccine news.  Here's tech (NASDAQ) versus the broad market (NYSE) since the pre-COVID highs this year, through Nov 5th.

Tech, red line, up 35% since pre-COVID.  Broad market, blue line, up less than 2%.

Here's the same NASDAQ vs NYSE for the last 7 days.  See if you can spot the Pfizer announcement:

That may not look like a whole lot, but that was a 15-standard deviation event in the "momentum" factor, and the worst 1-day momentum factor crash in the history of Nomura's dataset.  In other words, what had been working stopped working and vice versa.  Meaning my dividend stocks finally did something for me.  Awesome!  Wow!

For those of you who appreciate Bloomberg terminal screenshots, this is the 10-year data set of momentum daily returns.  A nice normal distribution.  And off on the far right was Monday's return, highlighted at the bottom with the red box:

So.  Gridlock in Washington, COVID vaccine, and it's basically back to business as usual, right?  Well...not just yet, we think.

On the election front, the outcome is technically still pending.  It's absurd (and a rather damning indictment of our electoral system...and perhaps education system as well?) that in 2020 we can't count votes in a day.  For all the tech we have at our disposal, electronic voting machines look like they still run on MS-DOS.  And why isn't there some kind of single comprehensive system for a federal election?  You can pay your taxes online, you can get your Medicare and Social Security online...but federal elections are handled at a county level?  C'mon.

In any case, votes have been tallied, and Biden seems to have enough for the victory, despite recounts and court challenges underway.  We suppose there is a nonzero chance that Trump holds on to the presidency...it would have to be a 15-sigma event, but apparently those aren't as rare as one might expect.  There is not, in this country, an official institution that "calls" elections, so the media proclaiming a victory is, in point of fact, meaningless until the various states clear the various legal challenges, certify results, and the Electoral College meets.  That's December 8-14, for those curious.  Meaning we the people have to wade through another month of muck.  

But let's assume that the current outcome holds.  We still won't know the composition of the Senate until January, when Georgia holds not one but two Senate runoff races.  If they both go Democrat, then the Senate is 50-50, with the VP being the tie-breaking vote.  Not quite what was meant by "blue wave", but there's still a chance Democrats could control the Executive and Legislative branches of government, which is pretty much what sent the market down 7.5% before the election in the first place.

If the Georgia seats split, then Republicans hold on to a 51-seat majority and likely spend the next two years until the midterm elections frustrating any Biden initiatives.  Presumably good for the stock market, but likely terrible for individuals, small businesses, and the economy as a whole.  And then on top of that, you've a significant chunk of the country that will feel - regardless of the election outcome - that the election was stolen.  Add in continued economic distress, whispers of various McCarthy-esque "enemy lists", and we'd euphemistically say there's no guarantee that 2020's social unrest fades quietly into the history books as the calendar turns.

As for the Pfizer announcement, it's certainly good news.  But.  Forgive us if we'd like to have a look at some actual peer-reviewed data instead of a presser before we start trading like bankruptcy risk is off the table.  Basically, Pfizer has something like 43,000 people in the study, and these interim results of 90% efficacy are being announced after 94 total cases of COVID were reported among the 43,000 in the study.

Here's what we don't know:  94 out of 43,000 is 0.22%.  Were all 43,000 even exposed to COVID?  It makes a pretty big difference if your trial patients are in COVID hotspots versus, say, Taiwan, where there have only been 577 cases on an island of 24 million.  Is the 90% efficacy constant across age groups?  Does the vaccine reduce the severity of the disease if you do still get it?  Does it reduce the infectiousness?

Again, let's take the results at face value and assume a 90% effective vaccine.  The expectations are that you could produce enough to vaccinate 25 million people this year and maybe 600 million next year, or a combined 8% of the world's population by 2022.  Difficulty accessing the vaccine may be compounded further by reports that it has to be stored at -60 to -70 degrees Celsius.  That's apparently not the easiest thing to accomplish.

Meanwhile, the US is accruing new cases at over 100k per day, New Jersey has just forbidden indoor dining, again, and Biden's new coronavirus advisor is advocating for a 4-6 week national lockdown, again (NB: that has been walked back by other advisors in the subsequent days), and rumors are that you shouldn't be expecting a big stimulus check out of Congress anytime soon. ​Also to be filed under "irony" à la Alanis Morisette, the first cruise in the Caribbean since all cruises were shut down in March has reported a case of COVID.  But sure, let's all trade like we have a perfectly functioning economy, full employment, and no bankruptcy risk.

More news on the virus front: Goldman is out with a research report anticipating a rough winter economically because - get this - according to their data, temperature has a larger predictive impact on COVID cases than variation in individual state responses to the virus.  The Lancet also put out a piece recently that found no association between border closures, lockdowns, and widespread testing (collectively: "public health policies") and incidence of critical COVID cases or mortality.  Public health policies likely (and somewhat obviously) impact total case load, but the researchers found no significant impact on incidence of critical cases or mortality.

In theory, that lends support to the WHO's new stance that lockdowns should only be a last resort.  Unfortunately, the study found that the things that did impact severity of cases and mortality were things like national preparedness, limited healthcare capacity, and population characteristics of old age, obesity, and higher unemployment.   That does not bode particularly well for the US heading into winter, when things tend to happen indoors for the 70% of the country that lives in snowy areas.

Preliminary data is optimistic that early vaccines will be more effective than anticipated and it seems like viral mutation may be slower than feared, making the vaccine more like an actual vaccine and less like an annual flu shot.  All in all, it looks like the US is trending towards herd immunity by mid-next year.  If that's the case, then great, 2022 and on could be great.  But there's likely to be a lot of volatility between now and then, mostly of the headline variety around various vaccine trial results.  When everything is priced to perfection, anything short of perfection is viewed as bad news.  Meaning it might be a good time to be thankful that the market is where it is given all that's happened this year, book some gains, and adjust those risk exposures.  Because while there are high hopes next year will be better than this one, it almost certainly won't be perfect.  But, in the words of Groffsauce himself:  Good luck!