Is the second lockdown beginning—and truncating a nascent recovery in summertime economic data along with it? That is the question posed by many financial commentators we follow as COVID case counts rise anew in Europe and new restrictions begin to materialise. A handful of French and Spanish cities announced new limits on activity over the past week, and UK Prime Minister Boris Johnson announced nationwide measures that will last for six months. Whilst these restrictions aren’t anywhere near as draconian as those implemented globally in March, headlines warn they are just the tip of the iceberg, jeopardising the recovery from this year’s global recession—and the bull market (prolonged period of rising equity markets) that began in March.[i] In our view, it is probably fair to presume new restrictions will slow economic growth this autumn and perhaps even cause data to wobble somewhat. But for investors, we think the most important question is always: Is reality better or worse than what equity markets have already anticipated? With many commentators globally warning of a disastrous second lockdown and devastating double-dip recession for months, we think reality thus far is shaping up better than feared. New restrictions can knock sentiment short term, which our research shows can contribute to market volatility. But in our view, there would need to be a massively negative surprise for equities to slip into a second bear market (equity market decline, driven by fundamentally negative developments, of -20% or worse).
Hard as it can be to remember when bad news arrives, a wide body of research—including our own—shows equity markets are forward-looking. In our view, they reflect the likely reality over the next 3 – 30 months, based on all information at their disposal—including economic forecasts, headlines, big fears, data and all other news and opinions. For the past six months at least, we have seen a vast array of headlines warning of a potential second wave of the virus. Even as case counts dwindled in the late spring and summer, many commentators we follow warned it was a temporary reprieve, and once colder weather forced everyone inside, the virus would flare up exponentially—paralleling the 1918 flu pandemic. With conventional wisdom crediting stay-at-home orders with containing the virus earlier this year, many commentators have argued for months that an autumn or winter return to full-fledged lockdowns was a foregone conclusion. Meanwhile, global equity markets kept rising until Tech-related jitters and other issues knocked sentiment this month.[ii] In our experience, when shares rise through widespread fears, they are most likely signalling they have dealt with these fears—and reality is unlikely to be anywhere near as bad as most people suspect.
That signal appears to us to be valid, based on everything we know now. None of the new restrictions—in France, Madrid or the UK—are anywhere close to what the world lived through six months ago. The affected French cities will still let stores, restaurants and bars operate, with restrictions limiting capacity and operating hours.[iii] That isn’t great for the affected businesses, in our opinion, but it is far better than early 2020. Madrid’s new restrictions are similar and confined to areas of the city where there are 1,000 infections per 100,000 residents.[iv] As for the UK, shops and restaurants in city centres that depend on office workers will no doubt struggle, as the government is urging everyone who can to work from home. But there, too, stores and restaurants will remain open, albeit with curtailed operating hours, and most social gatherings are now limited to six people.[v] Yes, economic activity may fall compared to August. But simply having most businesses open is a world away from the widely feared full lockdown redux. For stocks, less bad than feared qualifies as a positive surprise, in our view.
Now, none of this means case counts and lockdowns can’t get worse. But this isn’t forecastable, in our view, because lockdowns are political decisions. They depend on how politicians respond to the virus itself as well as sentiment amongst their constituents—both of which defy prediction, given the human element. One thing we have observed, however, is that the public mood toward COVID restrictions has shifted markedly since the spring. When governments first announced lockdowns, the public broadly supported them in America and Europe, based on many opinion polls published at the time. But that seems to have eroded in the face of the severe damage to people’s livelihoods, not to mention the reported delays in cancer diagnosis and other critical medical treatment as people stayed home for all but the biggest medical emergencies. Madrid’s new restrictions triggered big protests.[vi] Apparently sensing the public mood, Spanish Prime Minister Pedro Sanchez and French President Emmanuel Macron stress repeatedly that national lockdowns are out of the question. Even Johnson, now widely seen as the most cautious of the bunch due to his personal brush with the virus, has stressed that the aim of the new UK restrictions is to prevent something more draconian later this winter. Whether that projection proves correct, again, remains to be seen. But we think the lack of a political appetite for a full sequel is noteworthy.
In our view, the critical thing for investors to remember at this juncture is that markets generally move most on probabilities, not possibilities. Is a second sweeping global lockdown—one exceeding what markets are already factoring in—possible? Yes. Is it probable? We think it is soon to say. But given the volume of second wave chatter that equity markets appear to have dealt with since March, we think it would take something much, much bigger than what is presently under discussion to present a material negative surprise. Without solid evidence that this is at all probable, we think investors benefit most from staying attentive but disciplined. Focus not on the bad news in a vacuum, but relative to broad expectations. And remember that when investors broadly expect disaster, anything that qualifies as not disaster, however discouraging on the surface, has historically been good enough for equities to keep climbing, according to our research.
[i] Source: FactSet, as of 23/9/2020. Statement based on MSCI World Index returns with net dividends, 16/3/2020 – 22/9/2020.
[iii] “Lyon Introduces Tighter Restrictions Amid Surge in Coronavirus Cases,” Staff, France 24, 21/9/2020.
[iv] “New Restrictions Come Into Force in Madrid as Spain Battles Rise in COVID-19 Cases,” Lauren Chadwick, Euronews, 21/9/2020.
[v] “Coronavirus: New Covid Restrictions Could Last Six Months, Says Boris Johnson,” Staff, BBC News, 22/9/2020.
[vi] “Covid-19: Hundreds Protest Against Localised Madrid Lockdowns,” Staff, BBC News, 21/9/2020.
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