Pricing the Probability of Virus Risks

Research Framework Objective

• The analysis establishes a structured framework to navigate high uncertainty regarding coronavirus healthcare outcomes, their economic impacts, and subsequent effects on U.S. equity markets.
• The methodology maps three distinct economic growth scenarios to implied U.S. equity market levels to determine market-implied probabilities for each outcome.

Scenario Analysis & Market Implied Levels

• Baseline Scenario:
  • Assumes a temporary pause in reopening over the next few months due to increased virus spread, followed by smoother recovery as states adopt successful strategies from others.
  • Projects growth remaining above trend through 2022, with manufacturing and construction recovering quickly while face-to-face services lag until a vaccine is available.
  • Corresponding implied S&P 500 level is approximately 3,250, slightly above current valuations.
• Upside (Vaccine) Scenario:
  • Defined as a vaccine discovery occurring by the first quarter of 2021, based on probabilities derived from external "super forecaster" models like the Good Judgment Project.
  • Assumes a robust economic recovery with growth rates north of 6% in 2021, significantly exceeding the baseline.
  • Corresponding implied S&P 500 level is approximately 3,520, representing roughly a 10% upside from current levels.
• Downside Scenario:
  • Triggered by continued virus spread leading to significant renewed restrictions or voluntary caution, causing a reversal of recent economic improvements.
  • Projects growth stalling or turning modestly negative by late 2021, with recovery beginning at a much slower pace in 2022.
  • Corresponding implied S&P 500 level would revert to March lows if fully repriced into the market.

Current Market Dynamics & Forward-Looking Indicators

• May-June Trend: Markets shifted from a uniform positive outlook to weighting downside risks higher as case growth accelerated nationally.
• Recent Stabilization:
  • Early mitigation efforts in late June show tentative signs of stabilizing case growth in key states.
  • Market volatility in June resolved with levels ending roughly where they began early in the month, reflecting a tug-of-war between upside and downside probabilities.
• Vaccine Probability: Belief in the likelihood of an early vaccine is steadily increasing, providing balance to infection concerns.
• Critical Near-Term Catalysts:
  • Data in the coming weeks will determine if moderate restrictions (e.g., mask-wearing, offline activities) can control infection without full lockdowns.
  • Success in these measures would likely allow markets to relax downside concerns by demonstrating a "learning process" regarding controllable infection mitigation.