Some reasonably bullish thoughts on the fourth US wave

The headlines I’m seeing this morning are downbeat. They point to an imminent coronavirus wave from mutant strains and a continued rise in interest rates, two outcomes I have warned about. But I am ‘looking through’ these headlines because I knew they were coming. And so, my focus is on what comes next, some of which is positive. I will tell you why below.

The Fourth US Wave

Here are the respective headlines on the coming fourth wave from The New York Times and the Washington Post: “Biden Pushes Mask Mandate as C.D.C. Director Warns of ‘Impending Doom’” and “Biden, health officials sound alarm as signs of a coronavirus surge proliferate.

Not good. Here’s how the Washington Post put it:

An emotional Rochelle Walensky, director of the Centers for Disease Control and Prevention, went off script at a briefing Monday morning to demonstrate her alarm. Her words brought to mind a prescient warning from another CDC official, Nancy Messonier, director of the National Center for Immunization and Respiratory Diseases, who told Americans more than 13 months ago that their lives would dramatically change as the pandemic exploded in the United States.

“I’m going to reflect on the recurring feeling I have of impending doom,” Walensky said at a White House news briefing Monday. “We have so much to look forward to, so much promise and potential of where we are and so much reason for hope. But right now, I’m scared.”

To be honest, I’m scared too. I think people are underestimating the damage these more potent viral strains will do. In both Europe and Brazil, more young people are being hospitalized with coronavirus because of these new strains. In fact, the Washington Post article says the exact same thing is happening in the US: “Some hospitals reported admitting younger people with more severe disease.” And so, we’re facing a completely different animal now.

But the reason I am optimistic is how the first half of that Washington Post paragraph reads:

Some hospitals reported admitting younger people with more severe disease. That is evidence that vaccines are protecting people older than 65 who once were the most vulnerable…

What they’re telling you is the vaccines are working! This is telling you that the oldest, most vulnerable and most infirm are not going to the hospital because they’ve been vaccinated and those vaccines are protecting them. That’s good news.

Greg Martin, chair of critical care at Grady Memorial Hospital in Atlanta and a pulmonology specialist at Emory University School of Medicine, said most patients 65 and older have disappeared, probably because of vaccinations…

What happens next?

I think the evidence strongly suggests the fourth wave I’ve been predicting for the US since January will happen. You can see the case counts rising. But given the progress with vaccination and the economy’s adaptation to working around the virus, it’s not clear how much damage will be done.

First, it’s interesting how delayed the mutant wave has been in North America. I first wrote about its coming on January 13. And I predicted a dark winter. Yes, the winter in Europe was dark indeed. But, in North America, the mutant wave has come later. For us, it will be Spring when this wave hits its peak. It speaks to how well connected the continent is to the UK, given that the mutated strain causing most of the havoc now was spotted there first.

Second, we don’t know how problematic the strain that first ravaged the Brazilian Amazon will be. There are some indications this P-1 variant is outcompeting the B117 variant in parts of Europe. I don’t have the news sources to hand. So I am not sure how worrying that should be. But it could suggest the P-1 variant is more contagious. And if that variant has yet to hit the northern hemisphere hard, there would be still more turmoil to come.

Third, the US is really vaccinating fast now. According to the Washington Post, already 95 million people have been vaccinated. And the number of people who have received at least one dose of a coronavirus vaccine is 35.6% of adults and 28.6% of the total population. That’s really good news given what we know about hospitalization. Just as these mutant strains are ramping up, so too is the vaccination effort. And this will keep the hospitalization and death rates down. How far down? That’s the wildcard. We don’t know.

Fourth, we know that the last wave in the US did not cause GDP growth to fall considerably. Our experience in Q4 2020 makes me believe we can get through this next wave without a huge impact on the overall economy. The problem will be in leisure, hospitality and travel. Those sectors will be hit again due to economic rollbacks and changed consumer behavior as the wave becomes reality. It means more jobless claims, and therefore, a continuation of this K-shaped outcome.

The bond market

And so, given all of those predictions, it still makes sense to me that bond yields will continue to go higher, perhaps even in the face of the fourth wave becoming palpably real for more people. This morning, I awoke to 10-year US yields over 1.76%. They reached their highest level in 52 weeks at 1.776% overnight. And so, it looks like the march to 2% is happening without delay.

We’ve broken through 1.50%. We consolidated well above that level before now breaking above 1.75%. We are still testing this level but I expect us to consolidate and march higher toward 2%. Even as the fourth wave is hitting us, we will get some large inflation prints. And I also expect the economy to hold together. Plus you have the infrastructure bill waiting in the wings. All of this should be enough to support higher yields. Let’s see.

I will reiterate what I wrote on March 18:

So, the forward-looking view here is one in which the Goldilocks scenario is one where rates rise due to positive global GDP growth expectations but not so much that it derails the market or the real economy. And if the march higher in rates derails the advance in asset prices, it doesn’t necessarily have to derail the economy. In fact, it may be a good thing as valuations are universally stretched and signs of mania are all around us.

From a markets perspective, I think large cap tech stocks underperform while this plays out. Bank stocks outperform as long as the problems in commercial real estate remain contained. The cheapest hedge in this environment is for a crash down in yields because that’s opposite of where the momentum is now. And that’s the outcome which is most pernicious because it would be due to a crashing of economic growth expectations.

My View

So I would say my view is mostly bullish here in the short-term. I think the US is well on its way to vaccination. And other developed economies will be close behind. The light at the end of the tunnel is there. And the pain we feel now won’t last. But I would still buy insurance for a crashing of growth expectations.

Once the economy fully re-opens, there will be pent-up demand that will keep growth expectations elevated. It’s only afterwards, when we settle into the new normal that we will see the euphoria give way as people adjust to a new reality.