Coronavirus fears come back to haunt markets
The stock market recovery that saw some indices claw back two thirds of their February-March losses, looks like it has hit the skids, for now. The main global indices have fallen more than 1% in the middle of the week, and sentiment seems to be slipping fast. There are three main factors weighing on sentiment: fears about a second wave of coronavirus, rising US-China tensions and fears that central banks and governments will not be able to kick start the economic recovery.
Corona unleashes wave of uncertainty for traders
The trouble with Coronavirus’ impact on the financial markets is that it has stripped the markets of certainty. Before this virus was declared a pandemic, investors were pricing for a recovery in UK asset prices, stronger growth rates in the Eurozone and higher levels of government spending in the US ahead of the November election. That is all in the past now. While government spending and central bank largesse has surged around the world, the Covid-19 crisis has made uncertainty and fear about the future the new normal. With no recent update about the potential for a near-term vaccine, traders are left with a torrent of dire economic data along with a changeable R rate (infection rate) to utilise and make trading decisions.
So, what has changed? Up until last week traders were willing to look through the weak economic data and remain hopeful that the future is brighter. However, with new clusters of infections cropping up in China and South Korea and a growing infection rate in Germany, fears are starting to emerge about the potential for a second wave of the coronavirus. It was one thing to jump on the back of the Covid recovery trade when infection rates were falling globally, however that was when the world was in lockdown, without a vaccine or a treatment to eradicate this virus, the infection rate is being artificially supressed. As economies slowly start to open back up, the market is, correctly, starting to consider the prospect of a second wave of the virus.
Where will markets go next?
This does not mean that markets will crash back to the March 23rdlows, there is no need for such a decline, in our view, especially after the Federal Reserve said that the US economy may require further stimulus. While the announcement from Fed President Powell today was largely due to a weak prognosis for the US economy, the Fed is still flooding the economy with cheap money, which will no doubt seep into the financial markets in time.
Why Wall Street ignores Main Street
While the raw economic data is looking dire, the UK economy shrunk by more than 5% in March, when the UK had been on lockdown for only one week, financial markets rarely move in unison with the economic data. Hence, the record high in the FTSE 100 when the UK was in the thick of tense Brexit negotiations. Thus, don’t expect global stock indices to trade directly on the back of the economic data. Another example of this disconnect is the market performance last Friday. US stock markets rose on the back of the dreadful employment data that saw more than 20 million job losses for the US in April. Even the smaller indices, such as the Russel 2000 and the FTSE 250 have experienced this disconnect.
The question to ask now is, what will move stock indices? We believe three things will continue to determine the direction of the major stock markets:
1, US-China relations:any deterioration in this relationship will be bad news for market sentiment. We believe that an escalation of the rhetoric, or an increase in tariffs between the two nations will only exacerbate market fears about the future of economic growth and could lead to more declines in global stock markets. Going forward, if President Trump tweets something negative about China or if he increases the rhetoric in a press conference then expect an instantaneous market reaction, most likely to the downside.
2, Infection rates:if rising infection rates and new clusters of Covid-19 cases develop, and if this leads to more lockdowns or a delay to easing lockdowns in parts of Europe and in some US states, then we would also expect global risk assets, including stocks and commodities, to decline in value, and for safe havens like gold to rise. Gold has continued to rally in recent weeks, even as market sentiment has picked up, in a sign that investors had residual nerves around the Covid crisis even as stock markets were rising. Gold investors are being proven right for sticking with the yellow metal even as higher yielding stocks were riin recovery mode.
3, Vaccine:economic data is unlikely to boost market sentiment, even when some economic data is not as bad as expected (economists had expected an even larger decline for the UK economy for the first quarter). Reports of a pending vaccine have been quiet of late. We believe that there is only one thing that will fuel a sustained market rally- news that a trial of a vaccine has been successful and that it is going into production. Until then, we expect stock markets to oscillate between periods of high and low volatility and the major indices will not be able to return to their pre-Covid highs.