The second wave of the pandemic will likely drag Europe into a double-dip recession

Stock markets last week posted a slight correction due to the acceleration of the spread of the Coronavirus and the lack of a political agreement for Brexit and US fiscal incentives.

That said, losses suffered by stock markets are so far relatively limited in view of the circumstances.

The S&P500 index last week shed 0.5%, while the Nasdaq and Stoxx Europe 600 lost 1% and 1.4% respectively.  Sector performance varied considerably, with a clear rotation from growth stocks into cyclical value stocks. The sharpest corrections were in the technology and health care sectors, while automakers and banks still posted a rise. The latter was mainly due to a slight increase in bond yields, particularly in the United States, on expectations of a victory by the Democrats and massive fiscal incentives. Despite the generally better-than- expected quarterly results, share price reactions were only modest and any disappointment was severely sanctioned by the markets (e.g. Intel, IBM). These "sell-on-the-news" reactions can be explained by the fact that prices had already soared and the fourth quarter outlook is currently deteriorating.

Growing fears of a double dip in the fourth quarter

After the historical contraction reported for the second quarter, hurt by lockdowns, this week we expect the publication of impressive quarter-on-quarter growth figures for the summer months. However, the acceleration of the spread of the Coronavirus (which is resulting in record contamination numbers in Europe and the United States) and the increasing lockdown measures are raising doubts over whether the recovery can continue in the fourth quarter. In Europe, consumer and business confidence deteriorated in October. The composite PMI index even slid below 50 points (down from 55 points in July and 50.4 in September to 49.4 points), indicating a new contraction. The services PMI, the worst hit by the new restrictive measures imposed in the horeca & leisure sectors, even fell to 46.2 points. There is more personal interaction in the services sector, which is deterring consumers at present.

Note that the industrial PMI still managed to rise slightly in October, to 54.4 points. European industry continues to benefit from the good momentum of orders registered during the summer and strong exports to Asia. This confidence indicator will soon deteriorate too if quarantine measures and absent workers on sick leave begin to paralyse factories. The same is true in the United States, where PMIs have held up so far, but will soon fall victim to the second wave of the pandemic and the delay in the new incentive programme. It is most unlikely that an agreement will be reached on the latter point before the elections, so a fully drawn up and approved aid programme will probably only see the light after the (new) president is sworn in, i.e. in January.

Stock markets keep a cool head

Although the number of Coronavirus infections has beaten the record of the first peak (March/April) and the number of hospitalisations is accelerating at an alarming pace, stock markets remain relatively unmoved. The S&P500 index has lost only 4% since its peak in early September and is up 7% year-to-date. The European stock market is trading at around 6% below its summer record. Although this is still 13% below the early January level, it has climbed 34% since its March low. Since the strong recovery between mid-March and early June, the Stoxx Europe 600 index has remained relatively stable.

But why isn't this second wave causing the stock markets to panic as the first wave did in March? Firstly, because the uncertainty was much greater at the time. Secondly, we have more or less learned to live with the virus, and thirdly, we cling to the hope of a vaccine arriving within a few months. Finally, investors learned that the authorities and central banks are ready to do everything they can to mitigate the economic fallout from the health crisis. ECB president, Christine Lagarde, hinted that her institution was willing to introduce new monetary incentives if necessary.  As for the US government's aid programmes, so far they exceed 10% of GDP, but could be much more if the Democrats win the election.

To be honest, we had expected a slightly sharper stock market correction in view of the drastic second wave of the pandemic, the inevitable economic fallout, the political uncertainties caused by the US election, the difficult negotiations on incentives and Brexit. That said, we have always considered this kind of correction as an additional buying opportunity in anticipation of an economic recovery and an earnings recovery in the course of next year. And as most investors are likely to follow the same reasoning, a small correction is enough to attract bargain-hunters. 

Another exciting week ahead

We are in the final run-up to the US presidential election, so this week promises to be exciting on the political front. In recent weeks, Donald Trump's lag in the polls with rival Joe Biden has narrowed from 10% to 8%. Joe Biden has a comfortable lead, but it wouldn't be the first time the polls have got it wrong! Elsewhere, investors are still hoping for progress in the talks on fiscal incentives and Brexit. No action is expected from the ECB at its meeting this week…but perhaps in December? In China, a new five-year plan will be approved at the Communist Party congress that will probably forecast annual growth of 5% (versus 6.5% in the previous plan). That said, it is not that bad. China, where the Coronavirus originated, has since digested its first quarter recession and will be one of the few countries to register positive growth of around 2% in 2020.