Q1 2021 Variants, Volatility and Value
Clients of the Firm,
The first quarter of 2021 is ending. A year out from the peak U.S. shutdown, we sit on the precipice of a new era peering into the post-vaccine U.S. economy, albeit with the lingering impacts of the pandemic.
U.S. vaccination rates are accelerating, but due to variants and testing of school age children so are case counts. Experts warn that a new wave of COVID-19 may still be in our future, yet pandemic fatigue and state re-openings seem to be ignoring that message. The extent to which vaccinations exceed the rate of virus growth will be a significant factor in the pace of re-opening and "normalization" of U.S. life. As of today, vaccinations per day greatly exceed daily virus cases in the United States. According to the Washington Post, 2.76 million people were vaccinated in the past week, while virus cases were roughly 420,000 (according to Worldometer). While this is a substantial lead, the CDC reports variant replication rates for the U.K. and Brazil variants are 50% and 220% faster, respectively, than wild strain COVID-19. Thus, the U.S. must maintain its vaccination pace in order to prevent variants from becoming the dominant strains and their compounding replication rates surpassing the vaccination rate. You can track vaccination progress here: Tracking the covid vaccine: Doses, people vaccinated by state - Washington Post
Europe is faring worse in terms of vaccination rates and prevalence of variant strains. According to Statista, number of doses per hundred in most European countries are in the mid-teens with the notable exception of the U.K. which is 49.61 as of March 28, 2021. You can find the data here: Europe: COVID-19 vaccination rate by country 2021 | Statista. South America and Brazil in particular, are suffering mightily with the combination of the virulent Brazilian variant and weak hospital capacity. Brazil now has over 12.5 million confirmed COVID-19 cases and 314,000 deaths lagging only behind the United States on both metrics.
The gating factor for most countries emergence from the pandemic remains vaccine supply and distribution. This problem is being solved daily by the combination of more production by Pfizer and Moderna and new vaccine approvals for J&J, Astra Zeneca and Novavax. In addition, the Russian Sputnik V vaccine, which was successfully peer reviewed, is being offered in Russia and to its allies and offers a 91.6% efficacy (comparable to Pfizer and Moderna). While the pace of vaccination remains the most critical metric to finally ending the pandemic, the road to normalization may continue to be long and treacherous.
That said, the inevitability of victory over the pandemic, given the technological breakthrough of the vaccines, may have been priced into the stock market. Indeed, equities are reflecting a robust 23 times multiple of earnings with expectations for rapid improvement in the U.S.. The combination of this sentiment shift with $1.9 trillion of new stimulus has led domestic stock indices to new highs. Simultaneously, interest rates are increasing with the 10 Year Treasury hitting 1.77% today, a 14-month high yield. The culprit for rising rates is likely the absence of revenue (i.e. new taxes) to support the increased deficit spending for pandemic relief and inflation concerns. Instead, additional U.S. debt is being issued on a continual basis to fund this record relief package. This dynamic applies pressure on the fundamentals of bond prices.
In addition, pockets of froth in the market are being exposed as the recent Archegos swap debacle reveals. The extent to which leverage is too high in the system is also being laid bare by this case. Sometimes it takes losses, regulation, or both to wash out excessive risk-taking and it appears that may be the case this time as well. So far, the collapse of this hedge fund does not appear to represent a systemic risk to the financial system. However, it does represent a stark reminder of the dangers of being over levered for both brokerages and clients.
Looking forward for markets, we don't yet see the equity market pricing in a "roaring 20's redux" valuation. That is to say, the market is valued on reasonably conservative earnings estimates. If we do indeed see a rapid increase in demand, robust hiring and a true re-opening of the U.S. economy it is likely consensus estimates will be low compared to actual results. If multiples don't contract this would be a recipe for higher equity prices. Multiple contraction could happen under conditions such as a recovery setback, interest rates rising to levels that compete with projected equity returns or other sentiment dampeners (i.e. geopolitical crisis, inflation shock or systemic financial risks). The former risk scenarios are clear and present while the latter are always with us and should be considered in portfolio allocation.
Gary Cohn famously said, "If you don't invest in risk management, it doesn't matter what business you are in, it's a risky business". Helping clients define risk parameters around investment is crucial to evaluating the risk/reward trade-off for invested capital. Sometimes, risks are clearly balanced, meaning there is a discernable equally weighted bull or bear case for an investment. Other times, the risks are too heavily weighed against success and there is much more downside than upside. The rare value investment gem is found when the reward profile greatly exceeds the downside risk. This opportunity often comes at times of peak pessimism or price dislocation and tends to be the most profitable long-term. Investing at rational prices for long-term success leads to good investing outcomes and along with asset allocation helps us manage our risk as well.
We shall continue to keep you informed as market conditions develop. Thank you for your continued confidence in our firm.
Sincerely,
Peter C. Wernau, CEO
Wernau Asset Management
Important Legal Disclosure
This letter contains general information that is not suitable for everyone. The information contained herein should not be construed as personalized investment advice. Past performance is no guarantee of future results. There is no guarantee that the views and opinions expressed in this newsletter will come to pass. Investing in the stock market involves gains and losses and may not be suitable for all investors. Information presented herein is subject to change without notice and should not be considered as a solicitation to buy or sell any security. Wernau Asset Management, Inc. ("Wernau Asset Management) is a registered investment adviser with its principal place of business in the Commonwealth of Massachusetts. Wernau Asset Management and its representatives are in compliance with the current registration requirements imposed upon registered investment advisers by those states in which Wernau Asset Management maintains clients. Wernau Asset Management may only transact business in those states in which it is registered or qualifies for an exemption or exclusion from registration requirements. This letter is limited to the dissemination of general information pertaining to its investment advisory services. Any subsequent, direct communication by Wernau Asset Management with a prospective client shall be conducted by a representative that is either registered or qualifies for an exemption or exclusion from registration in the state where the prospective client resides. For information pertaining to the registration status of Wernau Asset Management, please contact Wernau Asset Management or refer to the Investment Adviser Public Disclosure web site (www.adviserinfo.sec.gov). For additional information about Wernau Asset Management, including fees and services, send for our disclosure statement as set forth on Form ADV from Wernau Asset Management using the contact information herein. Please read the disclosure statement carefully before you invest or send money.