Volatility in Context

Investment Commentary and Outlook as of July 9

Jul 9, 2020 | Industry Updates, Investment

This is the next installment of our series that addresses the effects of the COVID-19 pandemic on markets and economies.


What We Are Seeing on the Virus Front:

  • The US is experiencing a sharp resurgence in reported cases in many states, though estimated actual cases are still below the March peak nationally
  • Much of Europe has at least partially re-opened and virus cases remain in check for the most part, though there are concerns about whether some countries will be able to maintain this
  • East Asia continues to keep case numbers in check
  • The virus is spreading rapidly through much of Latin America, Africa and South Asia. In many countries, demographics may keep death rates low relative to the West, though there is increasing pressure on already weak health systems
  • Countries such as Australia and Israel, which looked to have successfully contained their outbreaks, are dealing with new flare-ups and are having to re-institute control measures


What We Are Watching

Markets have largely shrugged off news of renewed virus outbreaks in much of the US and the continuation of large, seemingly uncontrolled outbreaks in many significant emerging market countries such as Brazil, India and Mexico. In the US, markets seem to be in a “heads I win, tails you lose” frame of mind with respect to renewed outbreaks:

  • Government restrictions and/or more people staying home means more of a shift in spending from bricks-and-mortar to on-line, which benefits the large technology names (the top 5 now represent over 22% of the S&P500 market value – see chart below);
  • There is a higher likelihood of additional fiscal and monetary support, which should help prevent some bankruptcies and is generally supportive of higher risk assets. The looming US elections make additional fiscal support more likely.

There is also the backdrop of the significant fiscal and monetary stimulus already deployed and the fact that over 40% of S&P revenues are foreign. That means as European and Asian economies recover, large US companies should benefit as well, even if things stay slower in the US.

That said, there is of course risk:

  • Fiscal stimulus doesn’t come through as quickly or in the size that is expected;
  • The outbreaks in the US lead to more significant economic disruption than is currently forecast;
  • Stopping or reversing the recent reductions in unemployment; and,
  • The risk that the markets finally hit a valuation-driven tipping point for the most expensive companies.

Traditional valuation metrics are generally poor predictors of market movements over the short/medium term (months out to about 5 years), but over the longer term these do seem to show value. Markets, especially the US markets, are quite expensive on most valuation metrics today.


A Key Point of Clarification on US Covid-19 Data

Many readers who are following the change in reported US case numbers closely know there is a debate raging about whether these case numbers are rising for real, or simply due to increased testing. In addition, the number of people hospitalized is rising quickly in many places, yet reported deaths at the national level look to still be declining. What gives?

We have constructed a model that looks to estimate the number of actual Covid-19 cases both in the past and currently, which we think provides a much more robust picture of what is actually going on at a national level. We estimate death rates for all cases (known as the Infection Fatality Ratio, or IFR), which are derived from large randomized serology studies in places like NYC and Spain. We find that the IFR is likely in a range of 0.5% to 1% of all cases, including asymptomatic cases that are less likely to show up in official case statistics (as asymptomatic people are far less likely than symptomatic people to be tested). Using the mid-point of this range, an IFR of 0.75%, we find that the total number of cases in the past is many times the level of reported cases, though this multiplier has declined over time as the level of testing has increased. The chart below shows our estimate of actual cases, versus reported cases, over time as well as actual deaths lagged by 2 weeks (deaths lag cases by approximately this amount).

Based on the above chart, we estimate that new cases nationally are still below where they were in late March. If outbreaks continue to grow at recent rates in states such as Texas, Florida, California and Arizona, then we expect this “second wave” peak to surpass the initial one, which was concentrated in the Northeast, as regions with far more people are being heavily impacted.  Please contact us if you would like more information on our methodology in analyzing this data.


How Are We Positioned?

We have taken equity and other higher risk asset positioning to neutral, despite our macroeconomic models being firmly in the “Downturn” (risk-off) phase. We have done this due to the very significant, and seemingly effective, levels of fiscal and monetary support that have been provided. This has done much to relieve equity and credit investors of the risk of bankruptcy for many companies that would otherwise be at risk. We have not moved overweight because we believe that there is still too much risk that the Covid story has not yet played itself out and that there can be fatigue/diminishing returns/moral hazard with respect to additional fiscal and monetary support. Also, valuations (particularly important in the US), may matter once again.



As we have stated in the past, we see lots of progress in controlling the virus in some places, though even some places with seemingly effective procedures are seeing resurgences. In places where there has been limited attempt to mitigate spread, the results look rather predictable. Underneath the headline returns of markets we continue to see huge dispersion between valuations for different regions, sectors and companies. There is no natural limit to how far this dispersion can go, but we note that such dispersion has always reversed in the past, however the time frame is not always predictable.


To discuss your current situations with our team of experts contact us at USA@riverandmercantile.com

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