That feeling of déjà-vu
After falling by 3.4% in September, global equities lost 2.5% from the end of September. Bear in mind, though, that in February and March, they had plunged by 8.2% and 13.7%, respectively, as the virus spread and many countries around the world went into lockdown.
Investors went into risk-off mode. This was reflected by
- A jump in volatility in equity indices in the US and Europe where it returned to its highest since June
- Credit spreads on high-yield securities widening
- Oil prices dropping.
As had been the case earlier in the year, the rapid deterioration in public health caused equities to fall, mostly in the final week of the month, when they dropped by 5.3%. Despite an initial tightening of social restrictions and the introduction of curfews, the number of infections and hospitalisations continued to rise, forcing several governments – mainly in Europe – to consider re-imposing lockdowns. The US, too, saw a worrying increase in cases, not least including President Trump.
Controlling the virus is key for equity markets
In most of Asia, including China, the pandemic appeared under better control. This explained the outperformance of emerging markets. The MSCI Emerging Markets index rose by 2.0% in US dollars thanks to the rise in Asian markets. Emerging Europe, where the epidemic took a severe turn for the worse, fell sharply.
In developed markets, the Asia-Pacific region held up well: Australian and New Zealand equities rose and, in Tokyo, the Nikkei 225 index fell only marginally (-0.9%).
The difference in how US and European equities fared in October reflected both the political choices made in trying to contain the pandemic and a divergence in economic performance.
Recovery runs out of steam as Europe returns to lockdown
Recent economic indicators have confirmed the strength of growth in the US: third-quarter GDP bounced back by 33.1% (annualised rate). In contrast, in the eurozone, business surveys showed that the downturn seen in September worsened in October: the composite PMI index (which reflects the opinion of purchasing managers) slipped to below 50. The services sector was particularly hard hit by the new restrictions even before any decisions to re-impose lockdowns. The EuroSTOXX 50 lost 7.4% in October against -2.8% for the S&P 500.
ECB pledges to do more in December
The ECB’s 29 October press release on its monetary policy decisions said it would ‘recalibrate its instruments’ in December, i.e. come up with the optimal fine-tuned combination most likely to provide the best response to the economic crisis.
ECB President Christine Lagarde gave assurances that policy would become more accommodative. This heightened expectations of additional measures, which had been growing since the summer.
Lagarde’s highly dovish tone and her pessimistic analysis of the outlook helped to firm up expectations of a further cut in the deposit rate (cut to -0.50% in September 2019). However, for many market participants, an increase in the PEPP asset purchases envelope remains the preferred tool.
A clear message from the ECB is crucial at a time when eurozone third-quarter GDP growth surprised to the upside (+12.7% compared to the previous quarter), but also when the deterioration in recent business surveys and the renewed lockdowns are raising concerns of a contraction in GDP in Q4.
Short-term volatility; medium-term support
While global equities fell over concerns about the health situation, it seems investors are focusing more on the secondary effects of the pandemic – such as renewed restrictions on travel, social gatherings and economic activity – than on the details of the contagion and spread of COVID-19 itself.
Of course, the two are linked, but several governments in Europe have moved to less stringent and shorter containment measures than in the spring, perhaps to make them more acceptable by already long-suffering populations. For example, schools will remain open. This was not the case in the spring. Moreover, with the US facing a third wave of the epidemic rather than the second, as is the case in Europe, the country's local and non-federal decision-making processes should limit new restrictions.
As a result, the negative effect on activity is likely to be lower than in Q1 and Q2, although further GDP contraction is likely in the eurozone.
To the extent that governments have reaffirmed that the necessary stimulus will be put in place and central banks are saying at every opportunity that monetary policies will remain accommodative for several years or will even be loosened further, the medium-term scenario has not fundamentally changed and can be seen as containing favourable elements for risk assets, particularly equities.
However, there is a risk that nervous investors will react skittishly to suggestions of tighter, extended or more widespread lockdown measures.
Any views expressed here are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may take different investment decisions for different clients. The views expressed here do not in any way constitute investment advice.
The value of investments and the income they generate may go down as well as up and it is possible that investors will not recover their initial outlay. Past performance is no guarantee for future returns.
Investing in emerging markets, or specialised or restricted sectors is likely to be subject to a higher-than-average volatility due to a high degree of concentration, greater uncertainty because less information is available, there is less liquidity or due to greater sensitivity to changes in market conditions (social, political and economic conditions).
Some emerging markets offer less security than the majority of international developed markets. For this reason, services for portfolio transactions, liquidation and conservation on behalf of funds invested in emerging markets may carry greater risk.