Another Covid meltdown. What investors should know
Another Covid meltdown. What investors should know
Thu 29 Oct 2020
Markets drop as European lockdowns are reinstated
For the first time since March, the Coronavirus narrative is truly gripping markets. Before its open on Thursday, the S&P 500 was down 5.6% since last Friday, the FTSE 100 down 4.7% and Europe down 5.9% (7.3% after Thursday’s open).
The correction is widespread and we see more suffering in cyclical, rather than defensive, sectors, which suggests a proper “risk-off” episode. Yesterday, US tech companies, which should probably benefit, rather than hurt, from another lockdown, fell 4.5% presenting further evidence of a ‘risk-off’ sentiment from investors.
The reason behind this new volatility cycle is a massive pick up in Covid-19 cases in Europe, which led France and Germany into renewed lockdowns. The UK is widely expected to follow.
New cases are much higher now than during the previous peak, although this can be mostly explained by a higher testing capacity. Mortalities remain relatively stable although we should expect a rise in numbers in the next fortnight.
The situation is exacerbated by the inability of the Fed to deliver a policy initiative a week ahead of the US general election next Tuesday. Now only five days away, of which two of which are a weekend, so Fed Chair Mr. Powell can probably withstand some volatility before offering verbal (or actual) support for risk assets.
Covid-19 was an issue, a well predictable one, all through the summer, so why the ‘risk-off’ event now? The answer has many parts.
- Stimulus deffered: Part of the problem is that markets are often entranced with their own narrative, which is why, for a supposedly “predictive” mechanism, they are often actually surprisingly bad at predicting things. Markets seemed surpised, yet we already knew the period of mid-end of October is traditionally “Coronavirus season”. However, there comes a point which is usually impossible to predict when one narrative is overtaken by another. In this particular case, it probably happened because the $2tn+ US fiscal stimulus is so delayed. As the virus loads are picking up and it’s made apparent that we will have to wait until January for a stimulus package, markets now realise that this may tip the economy. Economists would prefer modest measures today, rather than wait for $3tn in late January, but political constraints are what they are. So, after US election day the Fed will be the markets’ only bulwark against a proper meltdown.
- Lockdowns are a surprise: While predicting a virus resurgence was not difficult, it had been widely accepted that March-type lockdowns against all retail activity would be avoided. However, the experience of France and Germany suggests that we could once again see the type of stoppage of economic activity we saw earlier in the year. Previous lockdowns caused Q2 GDP to collapse; 9% in the US; 12% in the EU; and 20% in the UK. Currently, consensus for Q4 predicts a 1% GDP rise in the US, +2.5% for the UK and 2% for the Eurozone. Renewed lockdowns are sure to cause significant downward revisions to both economic and earnings projections.
- The possibility of a contested election. In recent days, markets saw the widening between the two US Presidential rivals as a positive event, including the probability of a “Blue Wave” which would unlock wider legislation. The possibility of a 1-2 month contested election was always the “nightmare scenario”. The probability of which had begun to fade as the difference between Messrs. Trump and Biden widened after the first debate, to over 10%. The past couple of weeks have seen a resurgence by Mr. Trump closing the gap to 7.5%, which has revived the spectre of a contested election, a definite market-negative event. Although the difference is still quite large, just a few days before the election and with over 60m votes already cast, the all too well known by now nuances of the US “electors” system are enough to cast doubt on the outcome. Especially to determine the probability of one party controlling all three executive and legislative branches (Presidency-House of Representatives-Senate).
How should investors react to this renewed volatility?
- Wait for the Fed. Mr. Powell may not be practically able to intervene, but he could ask various other members of the FOMC to drop hints on further monetary action. These hints may go a long way for Fed watchers, but are less significant to political news commentators gripped in the fever of the election. In all other cases, markets can wait a few days for the Fed to respond.
- Hope for quick and clean US election outcome. This is really key to unlocking fiscal stimulus. Even if they have to wait for three months, the Democratic party can release details of a plan for January, to soothe market fears. If, however, we go into a protracted court fight, then it will be left on the Fed to pick up the burden, which will likely result in more asset reflation, against a contracting economy. This scenario is not great over the longer term, but it can at least contain volatility until the winner is decided.
- Hope for vaccines to be approved by January: at this point 4-5 vaccines are expected to be available, and that enough of the population can be vaccinated by the summer of 2021. Markets don’t really have a plan for a protracted pandemic beyond mid-2021. News of vaccines being rejected by authorities could have a significantly negative impact on markets in the current environment. Conversely, news of vaccines approved and working could stabilise markets very quickly.
- Trust in asset allocation. The idea behind asset allocation is very simple. Over time what really matters, is how and how often companies and countries are financed. As long as financing continues and financial markets remain the mechanism by which this happens, then there are gains to be made by asset allocators over the longer term, no matter the short term outlook.