The Coronavirus Is Not An Existential Threat - Buy The Pullbacks On SPY And Sell The Rallies On SPXS
Summary
- The COVID-19 outbreak originated in China with 85% of the cases limited to that geography.
- The coronavirus is not indigenous to any other country in the world. All cases of the infection in regions other than China are imported.
- New cases of COVID-19 in China are declining rapidly.
- The condition will likely be contained across the globe over the next couple of months.
- Buy the pullbacks on SPY and sell the rallies on SPXS.
Recent Statistics On The Spread Of The Coronavirus COVID-19 Demonstrate That The Disease Is Moving Towards Containment In China
Source: John Hopkins University Dashboard on COVID-19; Seamist Capital Presentation, March 2020
The epicenter of the COVID-19 coronavirus outbreak is Wuhan. Wuhan is a city of roughly 11 million people situated in the central province of Hubei in China. As per statistics from March 6, China accounted for roughly 85% of the COVID-19 cases, with a majority of the cases emerging around the epicenter of Wuhan. The disease is not indigenous to any additional regions of the world. However, COVID-19 is highly contagious and spreads easily from human to human. Given the magnitude of air travel from China, the infection has been imported to additional countries first from China, and then from country to country.
A Majority Of The Over 100,000 Cases Of The Coronavirus Infection Have Emerged Around The Epicenter Of Wuhan In China
Source: The Center for Health Protection of the Department of Health of Hong Kong; Centers for Disease Control and Prevention; Seamist Capital Presentation, March 2020
However, it appears that the infection is on a downtrend in China. The number of new cases is declining sharply, and the spread of the disease outside of Hubei is being contained. According to a March 6 note by Reuters, China had 99 new cases of the coronavirus recorded on the day, with 25 of these diagnosed outside Hubei, 24 of which are reported as imported from other countries. As per reports by the World Health Organization (WHO), over the recent weeks, the number of new cases being diagnosed in China is far less than those emerging across the world.
As per remarks attributed to a top official associated with a body created to battle the coronavirus in China, there are likely to be no more cases of the epidemic in Wuhan by the end of March 2020. Moreover, a hospital built specially to treat patients suffering from COVID-19 has been shuttered after all cases of the disease at the facility were resolved. The above-described elements bode well for rapidly containing the pandemic across the world. In addition, it is likely that COVID-19 will lose its virulence with the approach of summer as was the case with the Severe Acute Respiratory Syndrome (SARS) virus, whose genome is an 80% match with the COVID-19 genome.
Within China, as the magnitude of new cases continues to decline, authorities are likely to rapidly lift the COVID-19 linked restrictions on travel and industry, thereby embarking on a process of recovery for the economy which has evidenced a dramatic slowdown due to the outbreak of COVID-19 in the country. These developments are likely to swiftly reverse the deadlock in supply chains experienced by numerous industries in the United States.
As observed following the SARS pandemic and based on commentary from the International Monetary Fund (IMF), the economic recovery in China is probably going to be V-shaped once the crisis ends. According to IMF economist Kristalina Georgieva, "We now view a V-shaped impact" and "In other words, a sharp decline in economic activity in China, followed by a rapid recovery and a total impact on China relatively contained. Therefore, the impact on the world economy also contained".
The United States equity markets have experienced a dramatic sell off over the past month. The S&P 500, the Dow, and the Nasdaq indices have declined by 10.7%, 11.1%, and 9.9% respectively. Although the downturn has been broad based, companies belonging to the customer-facing industries such as airlines, travel, leisure, apparel, luxury, restaurants, and hotels on a relative basis evidenced the steepest downturns in stock prices. Additional industries that have been decimated during the stock market downtrend include marine, oil and gas, and copper. Following the SARS pandemic, a majority of firms in customer-facing industries witnessed their earnings/share plunge for a few quarters before embarking on a recovery. Empirically, it has been observed that while equity markets will typically overreact to short-term factors that have the potential to reduce earnings, the longer-term impact on the profitability of companies concerned remains virtually unchanged. Accordingly, we expect equities associated with these types of industries to languish over the short term and rebound based on their intrinsic value over the longer term.
The travel industry will likely be the slowest to recover. During the SARS infection, it took over six months for global travel to bounce back to levels experienced immediately prior to that pandemic. Given that the scope of the COVID-19 outbreak is more widespread, it is possible that the recovery will take relatively longer. Therefore, travel stocks will possibly continue to witness lower lows for a while.
United States Equity Markets Have Been Selling Off Since February 19, 2020
Source: Yahoo Finance; Seamist Capital Presentation, March 2020
Overall, equity markets experienced gains in the period that followed the initial reports on the SARS outbreak in February 2003. The S&P 500, the Dow, and Nasdaq evidenced increases of 13.3%, 11.5%, and 23.9% between February and June of 2003 when the SARS pandemic was raging. However, it is important to note that during the period, the United States economy was in the initial stage of an expansion, the global economies were experiencing strong growth, and the S&P 500 had a Price/Earnings ratio of 15. Conversely, presently, the United States economy is experiencing the longest economic expansion in its history, economists are modeling relatively modest economic growth for the United States and the world, and the S&P 500 is trading at 22x its Price/Earnings ratio. The recovery in the domestic stock market will have to adjust to these factors during the rebound.
Overall Domestic Equity Markets Rallied In The Months Following The Initial News Of The SARS Outbreak In 2003
Source: Yahoo Finance; Seamist Capital Presentation, March 2020
In our judgement, given the trajectory of the COVID-19 pandemic, it appears that the equity markets have already experienced the worst of the downside. Based on our analysis, we recommend that investors buy derivatives on the major indices, such as the S&P 500 Exchange Traded Fund Trust (SPY) and S&P 500 futures on pullbacks and sell the Direxion Daily S&P 500 Bear 3x Shares (SPXS) on rallies. Importantly, over the last month, the SPY has lost 10.5% of its value while the SPXS has gained 31.6%.
The SPY Has Declined And The SPXS Has Rallied Sharply Over The Past Few Weeks
Source: Yahoo Finance; Seamist Capital Presentation, March 2020
This article was written by
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