Market update: Assessing the damage done by Covid-19

Find out why Minerva Analysis believes that there could be some reason for optimism for financial markets.

After the worst quarter for financial markets in three decades, the start of the second quarter in 2020 has been another bleak day for asset prices. Equity indices in Europe are approx. 3% lower so far on Wednesday, US equity futures point to a similar decline on the other side of the Atlantic. The dollar is rising across the board, albeit at a slow pace than we saw last month, oil is lower, and gold is up more than 1.5%. Thus, volatility is inching back and there is a risk off tone to financial markets. Below we take a look at why markets are lower and how long that could last for, along with the factors that could determine the next move for equity markets, including why there may be reasons for optimism.
 

Why are markets lower?

We have had the big stimulus measures announced across the globe, Chinese manufacturing data has picked up at a decent pace, and there are signs that infection rates in Europe could be near their peak, yet still markets are selling off. This suggests to us at Minerva Analysis that one thing is on investors' minds: the US. President Trump issued a stark warning last night about the threat of coronavirus and said that his country faces a "hell of a bad two weeks". Most alarmingly, he even predicted that many thousands of deaths could occur, even with social distancing measures announced in the US in recent weeks. Experts in the US are now predicting up to a quarter of a million deaths could occur, which may lead to overrun hospitals and stretched medical supplies, and a lengthy period of quarantine and social distancing for the US. This is something that the financial markets have not yet priced in, mostly because up until a few days ago President Trump had said that the lockdown could come to an end after Easter. A lengthy shutdown of the US economy could spell a significant weakening for global growth this year and more economic pain that had been first thought. This, in our view, is the overriding concern for investors on Wednesday.

Other factors that have dented market sentiment include a torrent of weak economic data from Europe, including dismal PMI reports for March. Italy, France and the UK saw their PMI reports sink into contraction territory for March. The UK's service sector PMI for March is at its weakest ever level, after a near complete shut-down of our service sector.
 

Fears for the US labour market

This week's employment data for the US could also send a shiver down the spines of investors. Today's ADP report, which measures private sector employment levels, is expected to see a 150k decline in jobs last month. We believe that this figure now looks conservative, and the actual report could see a much larger decline. Of course, the main data point to watch is the NFP report on Friday, analysts expect a 100k decline, if this decline is larger than expected, as we think it will be, then we may see equity markets and other risky assets decline further as the extent of the economic damage sets in.
 

Bank shares are in the red after regulators step in

Banks are some of the biggest losers on the FTSE 100 today after regulators urged banks not to pay dividends or engage in share buy backs. We expect very little in terms of dividends from most blue-chip companies listed on the FTSE 100 in the current environment. Those sectors that could provide a dividend include supermarkets and the healthcare and pharma sectors, which may prove to be the biggest winners of this crisis. It is natural for investors to react badly to news that dividends won't be paid; however, bank shares may also be falling for a more sinister reason- fears about a financial crisis. The fact that regulators have urged banks to preserve cash could stoke fears that covid-19 has the potential to cause a financial crisis and a cash crunch for lenders. We believe that these fears are unlikely to be realised for two reasons. Firstly, the Federal reserve and other central banks have provided a huge supply of dollars to the financial markets (the universal currency of global finance). Secondly, central banks have back stopped the corporate bond market, which could ease funding constraints for companies and protect banks from a wave of bad loans down the line. Thus, the UK's banking sector may claw back some of today's losses once the news about dividends has been digested, but that will only happen once volatility calms down.

Overall, three things are weighing on sentiment in the middle of the week: firstly, Trump's gloomy assessment and the risks to the US from Covid-19, secondly, a wave of bad economic data and thirdly, sector-specific news. However, there is some good news that might eventually lead to a pick-up in global equity markets in the coming weeks.
 

Why there could be reason for optimism

In this section we take a look at two factors that could provide optimism for investors. While we would not suggest that day traders fight the presiding trend, especially when large investors are not willing to call a bottom to financial markets quite yet, keeping a level head is important. Eventually the tide will turn, and it is information like the below that will eventually build up and trigger a return to risk-seeking behaviour across financial markets. So, while this news is not yet triggering a recovery in financial markets, it may do so eventually.

• Signs that infection rates could be peaking in Italy and Germany. In Italy, net active cases are growing at approx. 3% per day and recovery rates continue to trend higher.
  
  If this recent trend continues for the next couple of days then Italy should see the peak of new infections by the end of this week and start recovering from next week onwards, as the number of recovering cases starts to rise significantly. The increase in new infection rates has also started to fall for Germany and Spain. Germany could see the growth rate in new cases peak this week, with Spain in the next 1-2 weeks, if current trends continue. The UK could see its peak in the new infection rate in 2-3 weeks' time. France is the weak link, its infection rate continues to grow, which suggests that its social distancing measures are not working as they should. This may lead to more stringent measures being put in place across France to control the outbreak. This data is from JP Morgan Cazenove's healthcare analysts, and Minerva Analysis has found it to be pretty accurate so far. The peak in cases is important to financial markets as it gives us a light at the end of the tunnel, which may reduce volatility in financial markets and boost investor optimism. If Europe joins Asia in entering a ‘recovery' phase, this may help to neutralise some of the concern around the US, where the management of the crisis has been critisized and the outbreak seems very far from the peak.

• The second reason for optimism is the Chinese economic data. The Caixin manufacturing index for March rose to 50.1, from 40.3 in February.
  
  This offers optimism in two ways: Firstly, the world's second largest economy is getting back to expansion territory, secondly, the sharp decline in economic activity caused by Covid-19 can be swiftly reversed once social distancing measures are eased, as has been the case in China for the last few weeks. While this data is unlikely to push the FTSE 100 back above 7,000 or the S&P 500 back above 3,000 any time soon, it still suggests that the global economy could get back on its feet quickly once emergency restrictions are lifted. This also reinforces how important the peak in infection rate is for financial markets, once we reach the peak it will, hopefully, be downhill from there. However, it is worth noting that Asian equity indices have not seen a major recovery even though countries like China, South Korea and Singapore have managed to flatten the curve of new infection rates. Thus, for a rapid and consistent recovery to take place in financial markets, we may need to see infection rates peak across the developed world.

Overall, there are some signs of optimism for investors, but the end of volatility is not yet in sight for financial markets, and the first half of Q2 could be a rocky one with elevated levels of volatility weighing on risk sentiment. Let's hope that there is only one wave for this virus, and that a vaccine can be found before the start of next winter. Minerva is currently reading ‘Pale Rider' by Laura Spinney, about the Spanish Flu in 1918. That pandemic had three waves and lasted more than a year, the second wave being the most deadly. Let's hope that global leaders, scientists and modern technology means that Covid-19 is put to bed after only one wave.