A slightly earlier update than usual from me as I’ve got a day off tomorrow – though the forecast of “strong winds and heavy rain” for North Devon does not sit particularly well with the day at the beach my wife has planned! Given the wetsuits and kids’ surfboards are already in the car, I think it’s too late to win this battle.
It’s been a very tough week so far for global equities, with the COVID-19 pandemic once again weighing heavily on market sentiment as case numbers continue to climb and major European economies head towards new lockdowns. Yesterday in particular saw equity volatility spike, marking their worst one-day performance since the early summer on news that both France and Germany are moving into forms of lockdown in the next few days. US equities also sold off as the country continued to see near-record numbers of new cases (the record was four days ago) and rising hospitalisations. Whilst comparing the ‘record’ European case numbers now versus the spring is not accurate, in the US the level of testing now is comparable to their ‘second wave’ over the summer. The record case numbers now highlight the pandemic is spreading further, and beyond urban areas into rural communities in states that escaped the worst of the first and second waves in the US. The moves in Asian equity markets have been far less dramatic and highlight how the region continues to experience far better Covid-19 outcomes as a result of more effective measures adopted during the first wave of pandemic and much higher compliance with quarantine regimes. For example, Taiwan has not seen a case of local transmission for 200 days.
The World Health Organisation said some northern hemisphere countries are facing a “dangerous moment”. With Europe in the midst of the second wave of the pandemic, President Macron yesterday announced a lockdown for France that will begin at midnight tonight and will last until at least early December. He told the nation “like all our neighbours we are submerged by the acceleration of the virus” and warned that the second wave “would probably be harder and more murderous than the first”. French citizens will only be allowed to leave home for essential work or medical reasons; all bars and restaurants will close but factories, schools and companies can stay open. The German lockdown, to begin next Monday, will also see bars and restaurants closed but is less severe than the French lockdown, with no ‘stay at home’ policy and two households still allowed to meet. To mitigate the economic damage, impacted businesses will be allowed to claim 75% of their November 2019 revenues. Meanwhile in the UK, which continues to follow a regional response with different measures being taken in Northern Ireland, Wales and Scotland and various tiers in place in England, the ‘R’ (reproduction rate of the virus) is now estimated to be 1.6 per an Imperial College London study carried out for the Department of Health. Imperial College tested 85,000 people in the week to the 25th of October concluding that around 100,000 people a day were catching the virus and case numbers are doubling every nine days. There was some encouragement from a slowing in the pace of the increase in case numbers in the North of England, but cases are now rising rapidly in the South East, South West, London and the East of England – all of which are said to have an R rate above 2.0. For the moment, Downing Street appears willing to continue to pursue regional restrictions. But if case numbers are indeed growing at such a rapid pace, the pressure will build for further interventions.
In terms of the vaccine, there was some positive news from the Oxford/AstraZeneca trial, which was seen to produce a robust response in elderly people. Pfizer also said that they hoped to know whether their vaccine was effective in the coming days. Another Imperial College London study of 365,000 adults highlighted the need for a vaccine given their study suggested antibodies fell off rapidly, challenging the concept of herd immunity and suggesting that the human immune system responds to Covid-19 in a similar way to the reaction to influenza and other coronaviruses such as the common cold.
In the US, with just a few days to go before the Presidential election, we have not seen a significant shift in the polls over the course of the week, with the polling prediction models still pointing to a Joe Biden electoral win, with the probability stable at around 88% and Democrats taking control of Congress with the probability of around 75%. There has not been significant evidence of a resurgence in polling for Donald Trump on a nationwide basis as we saw in the final weeks of the 2016 campaign. While both candidates spent the week touring the ‘swing states’, it appears the polls budging on rising Covid-19 case numbers across the Midwest swing states are unlikely to help President Trump given public perceptions of his administration’s handling of the pandemic. The early polling continues to point towards a very high turnout in the election, with over 71 million votes cast already – 52% of the total 2016 turnout. However, the volume of postal votes may well mean it takes a longer than normal for the result to be ‘called’. The outcome of most elections is usually known by midnight Washington D.C. time (5am UK time) but we may have to be more patient this time round. The focus will be on the ‘swing states’, which will provide clarity on the election results, not least Florida, Pennsylvania Wisconsin, Michigan, Ohio and North Carolina. While the overall picture may take some time to emerge, the results from these states should give us a good indication of which way election is heading. Each state has a different policy on the counting of postal votes. Florida is expected to announce results relatively quickly and this should be a good indicator of the eventual victor. Two of the most important swing states, Pennsylvania and North Carolina, allow postal votes that arrive up to three days after election to be counted so a very tight race may mean delays in declaring a result. Some patience will be required as early results may not be indicative of the final result and indeed we may well see significant volatility in the US overnight futures markets as a result. Whether this translates into market volatility will be determined by how long an actual result takes and if that result is contested.
Over recent weeks, markets appear to have priced in a Democratic victory in both the Presidential contest and the race for the Senate, with investors seemingly getting comfortable with the huge stimulus we would likely see from a Biden administration offsetting potential tax rises. The immediate issues facing whoever wins the White House will be the ongoing pandemic, but looking forwards, the economic recovery and the urgent need for more fiscal stimulus will be at the top of the policy agenda. This week we have seen very little in the way of progress on fiscal stimulus and the optimism of last week has been replaced by a more sombre view, acknowledging the difficulties of a consensus being reached during the lame-duck session of Congress between the election and the inauguration of the new President, meaning that significant new stimulus may have to wait until February next year.
We have seen two central bank meetings this week but no changes in policy. The Bank of Japan kept rates unchanged but did reduce their growth forecast for the financial year ending March 2021-5.5% from -4.7%. Meanwhile, the European Central bank (ECB) also chose to leave rates unchanged but did send a dovish message to markets that further asset purchases would be likely given the inflation outlook, the resurgence of the pandemic and the “current environment of risks clearly tilted to the downside”. The statement certainly suggests the potential for further policy measures when the ECB updates their economic forecasts in December.
In terms of the Brexit talks, we are in a stage where ‘no news is good news’. The talks that resumed in London late last week and were extended until yesterday appeared to be making some progress in working towards a legal text and while we still think there may be a need for intervention from senior politicians to bridge the gaps on the key sticking points the fact that the talks are ongoing, now in Brussels, suggests there is some momentum towards an eventual deal.
The economic data this week has seen the US report third-quarter economic growth of 7.4%, broadly in line with consensus expectations. The strength of the third quarter comes as no surprise given the slump of -9.0% in the second quarter, but it is worth a reminder that this still leaves the US economy 3.5% smaller than it was at the end of 2019. We also saw the flash PMI data which once again pointed towards strength in the global manufacturing sector but developing weakness in the services sector. We will see the full PMI data next week but the slowing services data across the UK France and Germany did suggest that this sector was seeing renewed impact from Covid-19 restrictions even before the new lockdowns are imposed. Hopefully the new restrictions will not cause too much of an impact for the resurgent manufacturing sector and it does help that the new lockdown measures are taking a more balanced approach in terms of keeping large parts of the economy open even as the service based economy, particularly travel, hospitality, leisure and retail will have to suffer. As one US research house put it “people can continue to work, but they can’t have fun”.
We appear to be in a difficult phase where Covid-19 case numbers are rising exponentially even before we get to the winter period when healthcare systems are expected (as usual) to be stretched. It does seem we will be moving towards a vaccine in the near future, but in the short term we can expect further restrictions to be imposed, which will necessitate further fiscal and potentially monetary stimulus from the authorities to mitigate the damage. The market reaction this week comes as no surprise, but we should remember that the financial system is in a better place than we were back in March thanks to the interventions of the central banks we have already seen and there remains significant scope for further interventions if necessary. What this does mean is that the economic recovery through the third quarter is likely to stall in the fourth quarter across western economies, but we are reminded that many countries across Asia and the Far East appear to be well past the worst of this pandemic and it certainly gives us confidence with our overweight allocation to Asian equities.
It’s a tough end to October with the Covid-19 resurgence, US election uncertainty and delayed US fiscal stimulus all weighing on market sentiment in recent days. Next week may well see further volatility not least (as mentioned already) if we see confusion or delays over the result or indeed a contested outcome. Equity markets like certainty and a definitive result next week will likely be well received. We should remember that while we are enduring market volatility this week there are still reasons to look forwards over the medium term more positively, not least if current restrictions are successful in flattening the second wave of the pandemic and if we do, as expected, see positive conclusions from the phase 3 COVID-19 vaccine trials. The US election outcome will likely allow a renewed focus on fiscal stimulus and we like to see further fiscal interventions across Europe supported by ongoing support from the central banks. It can be tough to look beyond the negativity in the short-term headlines, but we do think these market pullbacks can present opportunities provided investors have conviction that the short-term uncertainty around both politics and the pandemic will ease in the not too distant future.