Stay Cool Amid Second-Wave Worries

The S&P 500 fell -5.9% Thursday, its biggest one-day drop since March 16, apparently sparked by reports hinting at an emerging second wave of COVID-19 in select US states.^[i] This will no doubt further stoke widely held fears of the virus returning, renewing lockdowns and thereby causing markets to retest their late-March lows—or worse. But we think this is a time to remember that no market recovery moves in a straight line. Further, we think it is premature to suggest a second wave packing sufficient negative surprise to drive stocks materially lower for long is at hand.

In recent days, several states have reported increasing infection rates and hospitalizations, seemingly stoking this week’s volatility. For example, new daily cases in Texas and Arizona on Wednesday hit their highest level since the pandemic started. Oregon—which has largely avoided major COVID outbreaks—saw its highest reported new case totals on Thursday and paused its reopening for a week, forestalling plans set to take effect Friday morning. Hospitalizations also jumped in all three states, implying increased testing isn’t the only reason for rising caseloads. Several other states saw the percentage of positive tests climb. In Texas, Houston city officials said they may have to re-impose a lockdown, at least to some degree. It seems likely this news, which echoes fears existing throughout this crisis, drove Thursday’s sharp drop. But we think the market’s reaction looks mostly sentiment-driven. Whether a new wave packs more punch and renews or extends lockdowns beyond what investors presently anticipate remains to be seen. No one possesses any unique knowledge on this front now.

Market volatility—even extreme volatility—doesn’t tell you much on its own. Recoveries never move in straight lines. Such short-term swings aren’t predictable—nor do they predict market direction. As we documented Wednesday, there was considerable uncertainty coming out of the last bear market in 2009. While there was a sharp recovery off the March 9 trough then, it stalled in mid-June, not unlike 2020. From June 12 to July 10, 2009, the S&P 500 fell -7.1%.^[ii] In a familiar refrain, headlines warned stocks had climbed “too far, too fast” amid ongoing economic contraction and the advent of swine flu. Yet this weakness proved to be a countertrend headfake. Stocks resumed climbing in what turned out to be the early days of history’s longest bull market. In the aftermath of 1990’s bear market, stocks’ rally faced a brief interruption by a -5.6% slide from December 21, 1990 – January 14, 1991 as tensions between the US-led coalition and Iraq reached fever pitch.^[iii] Despite war’s commencing days later, stocks rebounded and kept climbing. To be sure, there are times like the October 2002 – March 2003 stretch when markets retested October’s lows. That could happen now. It also remains possible that stocks head lower than March 23. Yet both of those scenarios are quite far removed from where markets stand today. The key factor, in our view, is how reality lines up with expectations. Markets have been anticipating a second wave for months, which raises the question of whether the scenario we see now is likely to prove worse than what investors’ fears have already factored into stock pricing.

We think there are many reasons to doubt the theory a disastrous second wave is at hand. As one senior scientist at Johns Hopkins Center for Health Security remarked of the current uptick, “It’s small and it’s distant so far,” and the White House Coronavirus Task Force noted, there is no clear link between reopening and COVID’s resurgence.^[iv] Other reports back that assertion. Although headlines focus on hot spots, a second wave isn’t hitting everywhere—take early opening Georgia, for example. The state was the first to reopen, and despite isolated outbreaks, overall caseloads have plateaued. Colorado, another early reopener, has seen daily new cases decline. According to Johns Hopkins data, America’s 7-day case count rose by 1.1% through Wednesday, showing little change from the preceding. Perhaps forthcoming data will show a bigger bump, but it isn’t there yet.

Europe, which is further along in its reopening process, is seeing big declines. Italy has made remarkable progress since its worst levels in March—from over 6,000 new cases a day to well under 1,000 now. Likewise, the UK has seen its positive tests drop substantially since April. After reopening, caseloads for both have continued trending lower. France reopened a month ago. It saw an uptick similar to America’s now in late May, as daily new cases leapt briefly into the thousands from the hundreds—but health workers and hospitals were ready for it, and cases have flatlined at low and manageable levels since. Echoing some other countries, French authorities say they don’t need to return to lockdown even if there is a second wave because its health system is prepared to control outbreaks.

Other places also saw upticks after the disease began waning—e.g., China and South Korea—and didn’t experience much disruption. Last month, China saw new cases emerge in Wuhan, the city spawning the novel coronavirus, tested millions there, found 300 asymptomatic cases and brought the epidemic under control. Similarly, widespread testing in South Korea has allowed them to contain occasional outbreaks.

Many say the US doesn’t have as rigid a testing and contract tracing regime as those in Asia and Europe. Perhaps so, but in many cases, state officials say increased testing and tracing is responsible for some of the recent state upticks. That isn’t the case everywhere, of course, but we think it is worth noting. Hence, the idea an exponential resurgence is about to renew lockdowns broadly is very debatable, in our view. Absent that, we doubt the current second-wave worries generate enough of a shock to move markets for long.

We recognize that it is a significant challenge to stay even-keeled amid fearful headlines and steep volatility, particularly given everything investors have had to face over the past four months. Yet we continue to believe resilience is a key asset now—and one we think investors ought to rely on.