Markets burn out, but is this for real?

Markets had a meltdown on one of the hottest days of the year for the UK. What will a fourth Covid wave mean for risky assets? Get Minerva Analysis' view. 

There is a palpable fear in financial markets at the start of a new week. European indices had their worst day since October on Monday and were down more than 2%, US indices fared slightly better, closing the day down 1.9% for the S&P 500 and 1.25% for the Nasdaq. The biggest losers were those stocks closely linked to the end of Covid restrictions and to the performance of the global economy. The sharp rise in the Delta Covid variant has scuppered the recent market calm and has reignited fears about another global lockdown. The question now is, how likely is another lockdown, and are the authorities, and the scientists out of firepower? 

Delta fears: are they overblown? 

The market always overreacts, the question is, are the fears about the latest Covid variant to grip the world valid, and could there be a deeper sell off in the coming days? We would argue that it depends what your metrics are. If you look at infection rates, then you are right to have a panic this week. The UK has already seen an explosion in new cases; however, the hospitalisation rates have remained fairly low, and the death rates in countries with high vaccination rates are also low. The UK is reporting the second highest number of new infections at 44,671, which is the 7-day average (the stat that I have used for all of the figures below, unless otherwise stated). The UK infection rate is second only to Indonesia. However, India and Brazil, two countries that have been ravaged by Covid in recent months, have seen their 7-day average daily case rates fall to 38,550 and 40,948 respectively. The unsettling stat for financial markets is that cases are rising again in the US, which has reported another 32,136 new daily infections on average each day in the last week. 47 in 100 new Covid infections are now in Asia and the Middle East, however, rates are also rising in continental Europe and in the US. In the US, new infections are most prominent in Florida, LA and Nevada and they are rising in many others, including Rhode Island, Nebraska and DC. These states have seen increases above 150% in the past week. With growth rates like this, it doesn’t take a giant mental leap to figure out what will happen in the next 2-4 weeks – case rates will continue to rise and to spread to other states as Americans can travel freely within the country. The positive news in the US is that, like the UK, the hospitalisation and death rates, although rising, remain well below the level expected based on the current infection rates. This means the vaccines are working at limiting the strength of the infection, although not limiting its spread. The bad news in the US is the pace of vaccine doses given has dramatically slowed. Currently, at least 56.0% of the US population has one dose of a Covid vaccine. However, with the rate slowing, one has to ask, is vaccine hesitancy the reason for 1, the slowdown in the vaccination rate, and 2, the US falling behind other countries with its vaccination programme?  

Why vaccine rates in the US could determine Fed policy at Jackson Hole 

Vaccination hesitancy, and the prospect of less than 60% of the US population being vaccinated, which is not enough to create herd immunity, is a problem for the global economy. While vaccines work now, a big unknown for financial markets is the will they work in the future? Will top-up vaccines be required in the Autumn, if so, will the roll-out be as good as earlier this year and will the take-up drop? These are huge unknowns at this stage, and these are the risks that are being priced into financial markets right now. While it seems fairly probable that the Fed will stick to its dovish mantra at the Jackson Hole symposium next month, especially if case rates continue to rise globally and if markets continue in their current vein, the question is, what else can the central banks and governments do to prop up economies after all they have done already? Will there be further cheques sent out to individual households in the US? Will the UK Chancellor reinstate the furlough scheme? Will the Eurozone extend its bond buying facility? There is some fear that budget deficits in the world’s largest economies won’t be able to cope with more pandemic support, so recession and weaker corporate earnings could be in store. This is all weighing on stock markets at the start of a new week. 

The sectors that could suffer from the fourth wave 

The equity sectors most at risk are consumer discretionary, travel and tourism and banks. The biggest losers on the FTSE 100 at the start of this week were ITV, down more than 6% on the back of fears about advertising revenues if there is another economic meltdown, and IAG, the parent company of British Airways, which was down more than 5.23%. Lloyds Banking Group and BP were also weaker. We believe that banks on both sides of the Atlantic could suffer this week, even after US banks reported strong earnings for Q2. The risk is that loan losses will rise, and the prospect of this will weigh heavily on bank stocks, in our view. 

How to calm the market panic 

In the current environment, we need to hear from the doctors and the scientists to assure financial markets that vaccines will be effective and that the authorities have a plan to roll out booster jabs this Autumn. Any sign of hesitancy could be met with yet another sell off in risky assets. Interestingly, Treasury yields have remained fairly stable as the loss of risk appetite mostly focused on the stock market on Monday. For now, the 10-year yield is stable at 1.31%, and the 2-year yield has risen slightly to 0.25%. This is still significantly lower than a month ago, and also highlights how the sharp fall in Treasury yields two weeks ago was a good precursor to the current situation we are seeing in stock markets. Thus, watch the US bond market if you want to know what will happen to stocks next. 

Netflix: when bad news is not that bad 

Looking ahead this week, Netflix is expected to report weak subscriber growth, although revenue is likely to remain strong. However, we continue to think that streaming services, and other tech companies that do well in pandemic situations, will act as “safe havens” in the current risk off environment, so any decline in the Netflix share price could be a buying opportunity. 

Educated guesses: why the ECB will be dovish 

Elsewhere, the market sell off makes the ECB meeting later this week fairly easy to guess: we expect them to remain dovish in tone and alert to rising concerns about a fourth wave of the virus hitting the Eurozone economy. This could lead to a further weakening of EUR/USD, which has fallen below the $1.18 handle. Technical indicators have turned negative on the euro in recent trading sessions, and we could see a drop to $1.17, the low from the end of March, in the short term.