How and when will the COVID-19 crisis end?

There is no doubt that things will continue to look fairly grim for the next few months. Restrictions will persist, and infection rates will continue to grow. Stopping the spread of the virus was never an achievable goal; it has always just been about biding time. This crisis will only end once governments have provided a concrete solution. In this article we discuss why that is guaranteed to happen over the next few months, in our opinion.

Back in January our house view was one of the most pessimistic views out there. We quickly liquidated defensive portfolios completely, switched pensions into cash, and hedged entire portfolios with S&P500 puts. This proved to be the right call and is one of the reasons our investors are enjoying positive returns this year, when most major indices are substantially down. We were cautiously opportunistic putting risk back on, but didn’t tout the V-shaped recovery, in fact openly rejected that hypothesis. It was fairly obvious to most investment professionals (even those who were caught out by the pandemic to begin with) that the rally we witnessed in Q2 lead to a misalignment between markets and economic reality. It made little sense to invest in troubled companies, in particular in travel and leisure, while their fates were so uncertain and most of them hadn’t yet established technical bottoms. We recommended only one high conviction trade on numerous occasions over the last few months: Selling volatility at elevated levels. In retrospect that was a good strategy.

Today the overall picture looks more normalized. The inevitable damage to specific industries that we have been foreseeing is now palpable. Companies like EasyJet, Shell and Marriott (to mention 3 industries in the trenches) showed aggressive initial rebounds only to correct fairly rapidly and eventually settle into more realistic post-COVID ranges. A few months after a record rally insiders at EasyJet descried the company as being “on the ropes”. Today it is clear the company will require some form of aid. The charts of many similar stocks now finally show bottoms that have been tested and re-tested; support levels have emerged. It has also become clearer which companies are at risk of not surviving the pandemic at all. We selectively introduced exposure to airlines, energy and hotels over the last quarter, but steered firmly away from certain leisure stocks like Cineworld. There will be less air travel for the foreseeable future, but a baseline capacity will remain. However, it is quite conceivable that cinemas will be just about empty for many months (and certain chains will go under/consolidate), purely because most people view that as an acceptable sacrifice to make. Overall, we are in a much clearer position to assess the extent of the damage done now than we were a few months ago.

Added to that, by definition the longer this pandemic drags on for, the closer we are to a resolution. In February we believed 9-12 months was a reasonable guess and resultantly largely wrote off any chances of normality in 2020. Now, 8 months later, the initial estimate of 9-12 months is starting to look feasible.  

Here’s where we get to the reasons we believe we are approaching the beginning of the end of this crisis: It has little to do with being close to the end of what many perceive as a realistic timeline for rolling out a vaccine. The reality is safe and effective vaccine development takes much longer than 9-12 months, or even a few years. It took GSK about 30 years to come up with a vaccine for malaria. Granted, innovation has come along way since then. But the time taken was not a result of malaria not being urgent enough. Malaria has killed billions of people, more than anything else in the history of the planet. Yet there is a big difference between malaria and COVID-19 (beyond epidemiology): Malaria never had a material impact on the fundamental social and economic construct of our planet. COVID-19 in stark contrast has rattled that construct to the core, purely due to the policy responses we have opted for. The reason a vaccine of some description will almost certainly be available within a few months is because there is no alternative, and in the absence of a solution the world as we know it will essentially come to an end. Governments have progressively backed themselves into such a tight corner, that providing an actual solution is the last resort. It is a political impossibility to switch gears from valuing human life over economic cost, to doing the opposite. At the same time governments are aware (as are many who understand the intricacies of our global monetary system) that the current path is completely unsustainable. Shielding ourselves from the first two “waves”, as we have chosen to describe them, has been the most expensive exercise in history by a country mile, and the runway is getting shorter by the day.

To spell out the sinister undertone: We are now at the stage where governments have embraced fully the need to make a vaccine available at any cost. Fast-tracking trials, cutting red tape on regulations and pre-ordering millions of vaccines from multiple producers. Put another way: They are accepting the imminent roll-out of the biggest real-time vaccine experiment in history, even at the risk of compromising the lives of millions. The sum total of tracing, distancing, behavioural change, treatment, quarantines and huge amounts of stimulus and government support has merely been a band-aid on a haemorrhaging wound. As long as the spread continues, these policies will never be seen as adequate. Yet further spread is guaranteed. While a vaccine is unlikely to be a silver bullet in itself, added to the host of measures already in place, the problem virtually disappears. In fact, even if the problem doesn’t disappear, we all have carte blanche to pretend that it has. If a vaccine turns out to be sub-optimal years down the line, the world will already have moved on. Providing a vaccine makes it instantly politically viable to allow normal life to resume. The curse of having to weigh up the cost of lives against economic damage goes away. The vaccine is either highly effective, or an excuse to move on, but either way it’s a means to an end. There are currently 150 vaccines in development, and 30 of them are in phase 2 or phase 3 (final) trials. Given how big the stakes now are the likelihood of none of these being able to tick the box well enough for governments, is zero. That’s not to say that future forms of COVID won’t emerge, they are just highly unlikely to be accompanied by total shut-downs in the future.

Additional pressure arises from the fact that there is a huge amount of global competition to resume. The UK and Germany may be weary to cut corners, but China and Russia won’t be. China’s recovery is already far more progressed than others. Consider the lengths the USA and China have gone through to stay ahead of each other (a trade war which has lasted years amongst other things) – does the USA accept China rolling out their vaccine months or years before them, and stand by idly as China races ahead? Is it conceivable for the USA to be months behind Russia in releasing a vaccine? They weren’t too keen on Russia landing on the moon before them. Or, suppose Russia were to develop a perfect vaccine, a paragon if you will; do the UK, Germany, France and the US trust Russia enough to adopt it, and allow Putin to shine? Or do they come up with their own solution quickly, at any cost. Consider the monumental impact of protests and rioting in a country that hasn’t adopted a vaccine, while other countries have. It is not in the realms of possibility for a handful of countries to completely pull out of this pandemic, without the rest of the world following closely on their heels. The very same global pressures and connections that landed us in this pandemic are bound to pull us out of it. The world will miraculously end up with multiple “effective” vaccines in the space of 18 months, when it would have been more realistic to expect a single vaccine in the space of 5 years.

So while it is hard to say whether this continues for 2 months or 9 months it is almost certain that we’ll put COVID-19 behind us in 2021. Our base case is that at some point in Q1 or Q2 the latest this crisis will be over, and we will be dealing with the aftermath (which will last for years). It wouldn’t be completely surprising if some countries end up mass-vaccinating before Christmas. Whether a particular individual opts for vaccination or not is academic. Governments need to offer a solution, after that their hands are no longer tied. While many young, healthy individuals will refuse vaccines, it is likely the elderly and those with pre-existing health conditions will be more open. Either way, quarantines and shutdowns will be a thing of the past. Of course the repercussions of our current policies will ripple through the system for years (through austerity, tax increases, increased retirement ages, cost cuts, etc) but at least there will be a more predictable forward path.

Given the US elections are less than a month away it is likely that we will continue to see bouts of volatility at least until then, if not for a few weeks after. In a normal year Brexit and the elections would now be taking center stage in terms of market impact, but this year they really are a side-show to COVID-19. Either way, due to the confluence of all 3, it is unlikely that volatility will substantially subside before December. Trump contracting COVID seemed like it may have been a political Hail Mary for a few days, but it is now highly unlikely that he will be re-elected. We do not believe in a repeat of 2016; a Trump victory at this stage would be huge upset as opposed to an outcome that could have gone either way. The swing states we are watching are Florida, Ohio, North Carolina, Pennsylvania and Michigan. Trump winning more than 2 of those would be surprising, but even that would not be enough. We expect markets to gain some minor tailwinds as a result of a Biden victory who is likely to de-escalate the trade war with China.

Given our relatively optimistic medium term outlook, here is how we are positioning ourselves:

• We continue to take advantage of spikes in volatility when possible. This has been a reliable strategy for the last 6 months with volatility progressively coming down from 80 into the 20s. There have been, and likely will continue to be opportunities to trade with the VIX in the 30s, perhaps touching 40 in extreme cases. The levels of volatility seen in the first half of the year wont be seen again for a long time, so this window is slowly closing.
• We have increased our outright exposure to equities, mainly concentrated on high quality names, but we have also delved into higher beta stocks in sectors we believe will ultimately recover well.
• While we have sounded some warnings about tech, we continue to have healthy allocations and do not believe there is a risk of a tech bubble. Small wobbles are likely in the short-term but don’t change our long-term conviction.
• We now also have significantly higher conviction when it comes to a general recovery theme in cyclicals and value stocks than we did 6 months ago. This theme is interlinked with some of the rotation we have seen out of tech. The exact timing remains uncertain, but a gradual sustained recovery as economies continue to recover is probable. It is vital to be prepared to take a multi-year view as the recovery is unlikely to be smooth and consistent.