Monday, May 25, 2020

How Will the Second Wave of Covid-19 Affect the Markets?

NBHM Research Team

Health experts worldwide are warning of a second wave of coronavirus infections in the latter part of 2020. Will the global financial markets survive it?

 

As various countries ease their lockdown measures, warnings persist of a potential second wave of COVID-19 infections across different parts of the world. For instance, the biggest economy in the world, the United States, is already an epicentre of the pandemic, with 1,551,853 total cases and 93,439 deaths recorded as of May 21, 2020. Recently, the US Centers for Disease Control and Prevention (CDC) warned that the country may face a second wave of infections in the fall, with a large percentage of the population still susceptible to the virus.

Such an outbreak may wreak havoc on an already fragile global economy. Countries may have to retreat like they did during the first wave of the crisis, with mass business shutdowns and orders restricting border movements. Business leaders and experts are concerned that this will prolong the recovery trajectory of the global markets, which has not even priced in this risk.

Moreover, governments might not be able to provide more aide, after already spending trillions of dollars in fiscal stimulus. In terms of monetary policies too, there is now less room to manoeuvre.

Why a Second Wave?

What has been seen is that the novel variant of a flu virus like COVID-19 spreads across the world and recedes like a Tsunami. This can be attributed to change in seasons, from hot climates towards cooler areas. Viral transmission in a huge number of people gives them immunity against reinfection, known as herd immunity.

The COVID-19 virus is a tricky one though. It has not shown any signs of receding in hot weather conditions so far. Also, elaborate lockdown measures and movement restrictions in different countries have kept people far apart, so that the virus does not easily spread. Herd immunity in such situations will take a long time to be established.

On April 24, 2020, the WHO said that there is no evidence that people infected with COVID-19 have the required antibodies to protect them against re-infection. The pathogen can also mutate, which will make it unrecognizable to most people’s immune systems. In short, there is all possibility of the virus coming back. It happened during the 1918 Spanish Flu pandemic, leading to disastrous consequences.

Prolonged Recovery and Possibility of Depression with a Second Wave

The unemployment rate in the United States spiked to 14.7% in April 2020, with 20.5 million job losses. Experts suggest that that real figures might stand at 23.6%, not far from the levels last seen in the Great Depression of the 1930s. A gradual easing of lockdowns and the business environment is renewing hopes of taking that figure downwards. If the virus strikes again in the fall, the economy could plunge into a depression with unemployment levels above 10% for 12 months, according to Mark Zandi, chief economist at Moody’s Analytics.

The return could cause irreversible damage to consumer confidence and business operations. Household consumption constitutes 70% of the US economy. Reduction in consumption is already shrinking the US economy. American consumer confidence (University of Michigan’s Consumer Sentiment Index) fell to 71.8 in April 2020, from 89.1 in March 2020.

This shows that the economy is already in a prolonged recession. If a second wave of infections spooks investors, the country will experience an economic depression.

Conditions will further be aggravated by a devastating blow to oil demand, as predicted by the IEA. US crude futures declined in negative zone in April 2020, and from then on has somewhat improved. A further rise in cases will lead to many US energy companies closing their doors, leading to huge financial instability.

Battered Asian Markets will Face Catastrophic Losses

Asia’s key trading partner economies are expected to contract sharply, the US by 6% and Europe by 6.6% in 2020. China’s growth is expected to decline from 6.1% in 2019 to 1.2% in 2020. Overall growth in Asia is expected at 0% for 2020, the worst in 60 years, including the global financial crisis of 2008 and the Asian crisis of 1997.

According to recent reports, the Chinese economy is gradually recovering. A second shock could, however, destroy demand, industrial and supply chains as well as the domestic capital markets. Many of these economies in Asia will have overburdened healthcare systems, leading to millions of deaths.  

A V-shaped Recovery Isn’t Likely

Market analysts believe a second round of infections will plunge global markets down by 34% from the February 2020 highs. The market will transition to a deep bear territory for the rest of the year, well into 2021. Over 52% of fund managers surveyed by BofA Securities said that a second wave is the biggest tail risk for all markets, and it could lead to permanently high levels of unemployment, disintegration of the European Union (EU) and systemic credit risks.

This flouts all the possibility of a V-shaped recovery, which was until now touted as the best-case scenario. Under V-shaped recovery, global GDP levels recover slowly by the end of 2020, and while the economy doesn’t get back to where it should have been, it eventually reaches there.

A second wave of outbreak will most likely lead to an L-shaped recovery, where the global GDP reaches a level not seen since the 1929 Great Depression. Initial central bank and fiscal reforms don’t reach small businesses, which are pushed to close down as credit lines dry up. Any signs of recovery might not emerge until mid-2021.

Right now, a vaccine is the only hope for a delayed V-shaped recovery by Q4 2020. The pattern of this virus and its spread still remains an enigma for researchers and anything is possible in the near future. A vaccine could take up to 18 months or longer before it reaches the masses. Traders now need to consider their risk management strategies, as volatile markets seem to be here to stay.

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