Volatility collapse helps spur market sentiment, but will it last?
Investors are starting to see a light at the end of the tunnel for the Coronavirus crisis that has paralysed economies and financial markets for the last two months. The opening up of economies in China, Germany, Italy, Spain, New Zealand, and in some US states are helping traders and investors to imagine a brighter future where economic growth returns to pre-Covid levels. However, challenges lie ahead, and in this report we will illustrate four factors that could affect where risky assets go next.
1, The economic data turns ugly
May is the month that we get to quantify the damage done to the global economy, as it will encompass what a full month of lockdown looks like, in economic terms, for the 200+ economies that implemented quarantine to combat the spread of the virus. The data so far is ugly. Italian, Spanish, French and German manufacturing PMI reports dropped to the low 30’s last month, which is deep in contraction territory. German factory orders for March contracted by 16%, European and UK service sector PMIs dropped to their lowest levels ever, which are in the early teens, and US unemployment data for April, released this Friday, is expected to show a loss of 2.2mn jobs last month. This is horrible, and although investors are willing to look through it for now, the question is, how long will they tolerate these horrendous data prints. A dreadful April is to be expected, however, a worse US payrolls report than expected could knock market sentiment yet again. Afterall, if data is worse than expected then the economic recovery is likely to take longer. For example, if 2.2 million people did lose their jobs in the US last month, then these people are unlikely to be able to contribute to the economic recovery in any meaningful way as they park the purchase of big ticket items, and don’t have the money to splurge in newly re-opened shops or to book a foreign holiday.
Global stock indices have been a mixed bag so far on Wednesday, with the German Dax reeling from the negative factory orders report, but the US, Asian and UK indices all posting gains of 0.5% or more. While markets had staged a decent recovery in April, the start of May has been decidedly more unsettled, and if we get worse than expected global economic data in the coming days and weeks then the recovery in global risky assets could stall.
2, Commodities
This is an important sector of the financial market and it is worth watching closely. After the collapse in the oil price last month, the price of crude oil has bounced back, however the price remains volatile. After breaking the $30 per barrel mark on Tuesday, Brent crude was down 6% at one point on Wednesday. It perked up after the EIA announced that surplus crude stocks in the US have fallen to 4.59mn barrels from 8.91mn barrels last week, however, this news has yet to help the price of Brent crude to rise back above $30, although it is a rare piece of good news for the oil sector. We believe that the price of oil may continue to rise, however, we may not see it replicate last week’s surge. We believe that $35 per barrel for Brent crude and $30 for WTI oil are key resistance levels for the next few weeks.
We believe that the prospect of a profound recovery for the oil price is limited due to these demand factors. Fears continue to mount about the future of energy-intensive sectors of the global economy like air travel. Virgin Atlantic has cut a third of its workforce, and other airlines including Norwegian Air are desperately seeking government bailouts. It seems increasingly likely that demand for jet fuel will be under pressure for many months, potentially years, until a vaccine is found that makes air travel without the need for social distancing, safe again. With a V-shaped recovery for the global economy now unlikely, we believe the upside for the oil price is limited, even if future EIA data shows surplus oil stocks declining.
3, Data from the pandemic
The chief driver of financial markets will ultimately be the number of new cases of coronavirus. While the markets have been cheered by the decline in new cases, particularly in Spain and Italy, where the daily rate of new infection is now around 0.5%, the figures are inconsistent around the world. For example, the daily rate of new cases of coronavirus for the US and the UK are both more than 2%. Also, recovered cases of coronavirus remain stubbornly low, with the growth rate in recovered cases in Spain growing at approximately 2% daily, and 1.5% for the US.
We would also argue that the global data for coronavirus is understand at this stage of the pandemic due to lags in reporting and different styles of reporting across countries. For example, while the UK looks like it has experienced the highest number of deaths in Europe, we would argue that it will take many years to know each country’s Covid-19 death rate. It took more than 70 years for the global death rate of the 1918-1919 Spanish flu pandemic to be calculated at more than 100mn deaths. Thus, we believe that traders need to be very choosy if they are using Covid-19 infection and death rates to trade financial markets. We recommend that traders look at smoothed out data to try and find trends that might suggest that the worst of the virus is behind us.
German data is worth watching, firstly because Germany has lifted a large number of restrictions, thus it could be a test case to see if this causes another spike in cases. Secondly, Germany has been lauded for its response to the crisis, thus it could be a model for how to manage a large, global economy during a second wave of this pandemic. Germany has had nearly 7,000 deaths so far from Covid-19, it has had 167,000 confirmed cases of the virus, and it also has one of the highest recovery rates at 135,000. This recovery rate is particularly important, no other country appears to have the same level of recovery rate as Germany, near 80%. Now Germany is allowing households to meet and is restarting its football league. Thus, if other countries are to follow Germany and open up their economies, then we may have to see their recovery rates surge to German levels first. To put this in some context, in the US, the recovery rate is a mere 15%, thus a return to global economic normality could be some way off. (Covid-19 data is from the WHO).
4, Sweden
Sweden has been the chief outlier during this pandemic because it has not imposed economic lockdown. It has kept schools, businesses and restaurants open, although I have heard (through the grape vine) that some people have imposed their own lockdown to avoid the virus.
Sweden’s deaths per 100,000 people is 28, about on par with Ireland and the Netherlands. Interestingly, Ireland imposed a strict lockdown, the Netherlands also imposed a lockdown although it was less draconian than Ireland’s. Although Sweden’s case fatality rate is about double that of Ireland, we find the case fatality rate to be less reliable at such an early stage of the pandemic, we expect these numbers to change dramatically over the coming months and years, and we expect that it will probably rise for many countries that are now reporting numbers less than 10%. On the same basis, Sweden’s death rate is far less than the UK, Spain and Italy, however, there could be many reasons for that. It will take some further analysis, for example, normalising the data for demographics, before we can tell if Sweden’s model of avoiding lockdown to protect the economy was worth it. The economic data has been fairly thin out of Sweden in recent days, however, so far it looks like it has also suffered an economic downturn, although not to the same extent as other parts of Europe and the US.
Overall, if it is considered that Sweden has a “manageable” death rate (a very unpalatable word for this writer), then we expect the rest of Europe to adopt a more “Swedish” approach if there is a second wave of the virus later this year. If this happens, then we could see financial markets fret less over a second wave of the virus, and volatility to remain more stable if there is a second wave later this year. If we see Sweden’s infection rate decline in the coming days and weeks, then this may also boost the stalling recovery for global financial markets in the near term.
To conclude, there are many factors that could disrupt this financial market recovery. And while we believe that volatility may have peaked, we believe that the market recovery remains tentative in the short term. If you want to invest in global market recovery, then we would recommend a long-term strategy where there are undoubtedly bargains to be had if you can buy and hold. Thus, don’t expect markets to go up in a straight line for the time being, and watch the US Payrolls data on Friday. Don’t miss our analysis of the data once it is released on Friday afternoon.