What Would a 'Second Wave' Mean to Markets?

As countries “flatten the curve” and politicians debate the best way to reopen economies, a new concern has started brewing: COVID-19’s potential “second wave” prompting renewed lockdowns later this year. While 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.

A second wave could happen in a number of different ways. One, COVID-19 could come back during fall and winter. Experts aren’t exactly sure why, but influenza tends to strike during colder stretches, and COVID-19 could eventually behave with similar seasonality. Alternatively, the virus could mutate, becoming unrecognizable to most people’s immune systems—even those who already suffered from the first wave. Recent research indicates the coronavirus strain afflicting New York came from Europe rather than Asia—evidence of how the virus could change as it spreads over time. Still others think it is simply a matter of easing restrictions and social distancing too soon. Regardless of “how,” though, many pundits worry a COVID-19 return will again threaten to overrun health care systems and retrigger economic lockdowns. That could truncate any nascent economic recovery and/or prolong some interruptions to business and normal life.

Countries worldwide are concerned. While life in China has 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. In Europe, Scottish First Minister Nicola Sturgeon warned people in the UK should prepare for sudden, unexpected lockdowns if a second wave occurs. UK 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.

Today’s fluid situation presents lots of possibilities but no clear probabilities yet. Despite experts’ best efforts, many unknowns still surround COVID-19. There are myriad estimates and theories, but we still don’t know answers to key questions like:

• 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 is actually known about the situation, 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 stocks 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 materialize—or if it isn’t as severe as feared—the relief could bullishly propel stocks higher. Or, if a second wave matches expectations, it might delay an economic recovery but not necessarily send stocks reeling anew. But under a different scenario, animal spirits could heat up quickly once economies reopen—prompting people to largely dismiss both the a second wave’s severity and likelihood. Yet if COVID-19 returns with renewed strength and causes unexpected, new shutdowns, that could negatively surprise stocks and drive markets down significantly.

In our view, it is too early to assign probabilities to any of those outcomes due to all the unknowns. That means any possible scenario—whether optimistic or dire—isn’t a sound basis for investment decision-making at this juncture. Widespread talk about a second wave or another coronavirus-related story could knock sentiment in the near term and rekindle volatility. That could make keeping a cool head and rationally weighing potential outcomes against expectations difficult. But successful investing is based on probabilities, not possibilities. What does and doesn’t surprise market participants is a critical influence. We will 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 will help shape expectations and form probabilities. As hard as it is, we believe investors should remain disciplined and focused on what looks most probable in the near future—right now, it is still too early to determine.