How to navigate the Covid sell off 2.0

Global stock markets are tanking across the world on Wednesday as more lockdowns are announced for parts of Germany and France. Germany is poised to announce the closure of restaurants and bars, while President Macron of France is expected to announce more measures in a televised debate tonight. France is currently experiencing more than 500 daily deaths from Covid, while in Germany the infection rate has grown to more than 400,000. The French President is expected to say that intensive care capacity is back at levels last seen in April, which suggests that a blanket lockdown could be on the way for France. This has triggered a large sell off for French and German indices, which are currently down more than 4%, and the gloom has spread to other European countries and to the US, where the S&P 500 is currently down more than 2%. 

Looking for calm in the FX market 

The Vix index is at its highest level since June, and the sell-off has been broad based. Interestingly, gold, which is considered a safe haven, is also lower on Wednesday and is currently down more than 1%. US Treasuries are slightly higher, yields are lower, which suggests that there is a large scale sell off happening, and a limited amount of buying. Compared to stocks, the FX market is calmer, USD/JPY is basically flat, the dollar index, which is considered a safe haven is up 0.3% and EUR/USD and GBP/USD are both down 0.4%. For now, the threat of a second global lockdown to supress the second wave of coronavirus is driving global indices, however, the FX market may be taking a breather today as it waits for the ECB meeting on Thursday. We mentioned on Sunday that we do not expect any concrete action from the ECB at this meeting, i.e., we do not expect an increase in the Bank’s asset purchase programme or a further cut in interest rates. Instead, the focus will be on the ECB’s statement and on the press conference from ECB President Lagarde.

What to expect from the ECB after the sell off 

Event risk is building ahead of tomorrow’s meeting. If the ECB does not sound like it is ready to “do what it takes” to protect the European economy, then we could see a further sell off in European stocks. On balance, we expect Lagarde and co. to suggest very strongly that further support is available, and that the central bank is not out of ammo just yet. We also expect Lagarde to talk down the euro, which remains at elevated levels even though it has backed away from last week’s $1.1860 peak. A pessimistic ECB, combined with elevated levels of volatility is likely to weigh on the euro in the next two days, however there is one scenario where the EUR may not move too much on the back of this ECB meeting. This may occur if the ECB references the programmes and packages already in place to deal with the economic consequences of a second wave of coronavirus. For example, if Lagarde says that there is enough fire power in the ECB’s bond-buying package, and in the European Stability Mechanism, which is the fiscal support package agreed by the EU in the summer. If no further stimulus is hinted at, and if Lagarde only makes a cursory reference to the euro, then we doubt that any euro weakness will last for long. 

Where do stocks go next? 

At this stage, the relative calm in the FX market is to be expected since everyone is waiting for the outcome of the ECB meeting on Thursday. The stock market reaction is less clear cut. On the one hand, why is the selloff happening now? Rising infection rates in Europe and elsewhere have been documented by the media for weeks now, likewise the prospect of more lockdowns and restrictions have also been on the cards for some time. While it is understandable that the prospect of another lockdown in Germany has spooked markets since it is the largest economy in Europe, newspaper reports this morning suggested that Germany would put in place “lockdown-lite” restrictions. Although bars and restaurants may be forced to close, other parts of the economy would remain open, including schools and childcare centres, which would allow growth in the non-service sectors of Germany’s economy to go on as normal. Thus, we do think that today’s sell off in the Dax is an overreaction, and we could see it slow in the coming days. 

Why Amazon is at risk during a second wave of coronavirus 

The sell-off in Europe has also hit the US and the commodities market. Jitters ahead of next week’s US Presidential election are to be expected at this stage. We mentioned last week that the biggest uncertainty/ risk associated with the election is the prospect of no clear winner on 3rd November. Some may wonder why a company like Amazon is down nearly 3% today, which is more than the broader index, especially if the world is on the cusp of another lockdown. Surely, in this environment, Amazon’s share price should be rising as shopping on the internet giant is likely to surge once more. This is a valid argument; however, it forgets that Amazon and co. in the tech sector could be under more political pressure if: 1, Joe Biden and the Democrats win in a blue wave in next week’s US elections. 2, governments in Europe could get serious about implementing a tech tax, or an online shopping tax to help pay for the efforts to combat the coronavirus. Also, governments around the world could force the tech giants to pay much more in corporation tax in the coming years to help boost government coffers that are depleted by the coronavirus. 

Thus, financial markets are in panic mode, even those companies who you would expect to benefit from national lockdowns are under pressure on Wednesday, as the focus shifts to the economic damage and the huge bills that will need paying as a result of coronavirus. Add into the mix a highly contentious US Presidential election and we could see market jitters over the coming days and weeks, even if we believe the selloff in the Dax has gone too far.