Three reasons why the latest coronavirus news may not dent market sentiment in the long term

he week ended on a muted note as economic and geopolitical news turned sour. A double dip recession is now looking increasingly likely across Europe as Friday’s PMI data showed an abysmal performance for services sector across the currency bloc, and also for the UK. In the UK the service sector PMI for January fell to its lowest level since June. There was more bad news from the UK later in the day, when Prime Minister Boris Johnson announced that the new Covid variant found in the UK back in November, is deadlier than the original version that was detected a year ago. Recession prospects and a deadlier Covid variant than originally thought does not pair well, and risk assets could take a hit at the start of next week. 

Digging into the latest Covid news 

Looking at the latest Covid news first, we anticipate that this will take centre stage across the world in the coming days. The detail of the UK variant’s deadliness suggests that for men over the age of 60, out of every 1000 Covid patients, 10 would die if they had the original variant. The new UK variant pushes the death rate up to 13-14 per 1000 Covid patients. This means that the death rate for the UK variant, which is now the dominant variant in the UK and is rapidly spreading around the US and Europe, has increased from 1% to 1.3- 1.4%. It is worth noting that the higher death rate is still significantly lower than the death rate for the Sars outbreak in 2002, when the death rate was as high as 10%. However, the concern with the new UK variant is that is significantly more transmissible than the original Covid variant, between 30% to 70% more transmissable, which is what makes this new Covid strain so damaging. There are plenty of deadlier virus’ than this latest variant of Covid-19, but they are not as transmissible. If a virus is highly transmissible then by its nature, it is  more deadly, simply by the fact that it can reach more people. The key risk is if the Covid-19 virus is mutating and becoming deadlier than the speed at which we vaccinate the global population. As this question is analysed, we think that it could be particularly bad for global airline stocks and the travel and tourism sector. 

What we can learn from China 

But we don’t think that everyone should ditch risky assets and rush into safe havens straight away. While we do expect a pullback for risky assets in the short term, it’s worth noting that there hasn’t been any major shock to financial markets even though the Sinovec vaccine, developed by Chinese scientists and distributed across China and the Middle East, along with parts of South America, has been found to be only 50% effective in protecting against Covid-19. The Hang Seng and the Shanghai Composite remain close to multi year highs for now. Of course, the concern is that the new variants of Covid eventually find their way to Asia and the Sinovec vaccine is not effective at stemming their spread through populations. There are signs of rising infection rates in Hong Kong and China, and Hong Kong is locking down parts of the Kowloon area after soaring infection rates. This is the most significant step from Hong Kong to stop the coronavirus in nearly a year. This is one of the largest risks for financial markets, in our view, as China’s economic growth has been pivotal to the global economy throughout this covid crisis. China grew at an annual rate of 6.5% last year, but if infection rates start to rise again then China’s growth rate could be at risk, which is a serious concern for financial markets. If China gets locked down again, that is the time to rush to safe havens. 

US earnings remain upbeat 

On the positive side, earnings in the US have mostly impressed so far, of the 62 companies that have reported Q4 2020 results in the S&P 500, 89% have beaten analyst estimates. This includes the major banks, railroad companies and Netflix. Investors could be cautious about adding to new positions ahead of key events next week, including earnings from Facebook, Apple and Tesla and a Federal Reserve meeting. Of course, in reality, decent earnings results for these major companies should be enough to limit a serious decline in stock markets, at least in the short term.  The Biden Presidency has, so far, done nothing to stop the S&P 500 in its tracks, and although it dropped slightly on Friday, it remains close to record highs as President Biden dismantles the divisive and messy politics of his predecessor. But, as we have said since the start of 2021, the key asset class to watch is us government debt. 

Treasury yields suggest that risk could be in favour for some time

The 10-year treasury yield had been rising for most of 2021, it has dropped slightly on the back of weakening economic data in Europe and signs that the more transmissible variant of the coronavirus is infecting more people across the world, including the US, however, it remains at 1.09%, which is the highest level since before the Coronavirus crisis started. Right now, rising treasury yields suggests that markets are willing to have faith in the Covid vaccine and focus on the end of the coronavirus pandemic in the coming months. Rising yields are also not having an impact on the dollar, and there seems to be a fetish in the market to sell the dollar, even though the US economy is easily out-pacing Europe’s economy and yields are rising at their fastest rate in many years. What comes next for the dollar could depend on the Fed meeting next week. We will talk more about the Fed meeting in later notes, for now, as long as the dollar is falling, then markets are likely to remain happy to continue buying risk.