What Might a COVID-19 Second Wave Mean to Markets?

As countries try to flatten the curve of COVID-19 infections and fatalities and politicians debate the best way to reopen economies, we have observed a new concern starting to brew in the financial publications we read regularly: a potential second wave of COVID-19—another surge in cases—prompting renewed lockdowns later this year. Whilst we agree a second wave could happen, we think there are far too many unknowns about this possibility to let it factor heavily in your investment outlook—which should sway on probabilities, in our view.

A second wave could happen in a number of different ways. One, COVID-19 could come back during autumn and winter. Experts we follow don’t have universally firm conclusions as to why, but influenza tends to strike during colder stretches, and COVID-19 could eventually behave with similar seasonality. Alternatively, the virus could mutate, becoming unrecognisable to most people’s immune systems—even those who already suffered from the first wave. According to recent studies from the Icahn School of Medicine at Mount Sinai and the New York University Grossman School of Medicine, the coronavirus strain afflicting New York came from Europe rather than Asia—evidence of how the virus could change as it spreads over time.^[i] Still other experts we have encountered in our research think it is simply a matter of easing restrictions and social distancing too soon. Regardless of how, though, we notice many news commentators worrying a COVID-19 return will again threaten to overrun health care systems and retrigger economic lockdowns—potentially truncating any nascent economic recovery that may be in progress at that time and/or prolonging interruptions to business and normal life.

Countries worldwide seem concerned about this possibility. Whilst life in China appears to have mostly returned to normal, officials there have imposed new restrictions in certain northern regions—particularly Harbin, a city of 10 million—after a spike in new infections locally.^[ii] Scottish First Minister Nicola Sturgeon warned her constituents to prepare for sudden, unexpected lockdowns if a second wave occurs.^[iii] Prime Minister Boris Johnson—officially back to work after falling ill with COVID-19 himself—echoed that sentiment, saying the government would have “to slam on the brakes of the whole country and the whole economy” if a new wave emerged.^[iv]

In our view, today’s fluid situation presents many possibilities but no clear probabilities yet. Despite experts’ best efforts, many unknowns seemingly still surround COVID-19. There are myriad estimates and theories, but we think answers to many key questions remain unknown. Such as:

• How contagious is the virus?
• How does that affect the disease’s infection rate and fatality rate?
• How many people currently have or already had it?
• Does having the virus confer lasting immunity?

Moreover, those questions are just about the virus itself. Would politicians and institutions react to a second wave the same way they did to the initial outbreak? Would rules be more or less restrictive? What lessons will they learn (if any) from this go-round that shape how society approaches the coronavirus moving forward? Since so little seems actually known about the situation, we think it is hard to assess the likelihood a second wave provokes another round of lockdowns.

Right now, monitoring sentiment is key, in our view, as our research shows equities generally move most on the gap between expectations and reality. Consider some possible scenarios from an investment perspective. If second wave fears remain prominent, perhaps that weighs on markets and sentiment somewhat in the near term. Yet if another outbreak doesn’t materialise—or if it isn’t as severe as feared—it is possible the relief could propel markets higher. Or, if a second wave matches expectations, it might delay an economic recovery but may not necessarily send shares reeling anew, in our view. But under a different scenario, we can envisage investor sentiment heating up quickly once economies reopen—prompting people to largely dismiss a second wave’s severity and likelihood. Yet if COVID-19 returns with renewed strength and causes unexpected, new shutdowns, we think that could negatively surprise equities and drive them down significantly.

In our view, all the unknowns make it too early to assign probabilities to any of those outcomes. Hence, we don’t think any possible scenario—whether optimistic or dire—constitutes a sound basis for investment decision-making at this juncture. We wouldn’t rule out the possibility widespread talk about a second wave or another coronavirus-related story knocks sentiment in the near term and rekindles equity market volatility—potentially making it difficult to keep a cool head and rationally weigh potential outcomes against expectations. But in our view, successful investing is based on probabilities, not possibilities. Hence, we think what does and doesn’t surprise market participants is a critical influence on equities’ direction. We think we will likely get more information in the upcoming weeks and months, not just about COVID-19 but also the success (or lack thereof) of nations’ plans to reopen their economies. All the information should help equity markets shape expectations and form probabilities, in our view. As hard as it is, we think investors should remain disciplined and focused on what looks most probable in the near future. Right now, that still seems too early to determine, to us.