Markets beware: the tight US election is a sign that the worst is yet to come

The second wave of Covid-19 has been overshadowed by the US election. But the better-than-expected performance of Trump, with his anti-lockdown stance, presages a longer uphill battle against Covid-19 and more bad news for the global economy

Nicholas Spiro

Published: 3:15pm, 5 Nov, 2020

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For the past several months, Covid-19 has vied with the US presidential election as the main determinant of sentiment in financial markets.

In Bank of America’s monthly global fund manager survey, the outcome of the election and the damage wrought by the pandemic have been the top “tail risks” since February. Yet, while respondents to the survey have been sensitive to the threat of an inconclusive election result – almost two-thirds of those questioned in last month’s poll believed the result would be contested – they have been unduly complacent about the resurgence of the virus.

In the latest survey dated October 13, 60 per cent of respondents said the global economy was in an “early-cycle phase” as opposed to a recession, anticipating that the contractions in output would collapse to pre-pandemic levels.

Given the dramatic resurgence of the virus – the number of new daily cases in the European Union and the United States surpassed their first-wave peaks in mid-September and late October respectively – such optimism is woefully misplaced.

The second wave of the virus has been overshadowed by America’s momentous election. Investors had hoped that a clear-cut outcome would reduce some of the uncertainty that has plagued markets in recent weeks. Instead, the election has been much closer than anticipated.

Not only did President Donald Trump’s stronger-than-expected performance dash expectations of a decisive Democratic “blue wave” sweeping the White House and Congress, Trump’s team is contesting the legitimacy of a victory by Joe Biden.

Yet, even on the eve of the election, there were signs that fear of the second wave was proving more potent sentiment-wise than the declining probability of a blue wave. Last week, the benchmark S&P 500 stock index fell 5.6 per cent, its worst week since the virus-induced rout in March, despite the fact that Biden remained the clear favourite in both the polls and prediction markets.

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The sell-off was mainly attributable to the reimposition of nationwide lockdowns across Europe, a stunning reversal of fortune for a region that at one point appeared to have the virus under control and, just as importantly, had convinced markets that it would not reinstate countrywide lockdowns.

The resurgence of the pathogen across the EU is a body blow to the global economy, shattering confidence in advanced economies’ ability to contain the virus, increasing the likelihood of a double-dip recession in Europe and fuelling concerns that the US – which is also experiencing an exponential rise in infection and hospitalisation rates – is following the same trajectory as Europe.

In a report published last Friday, JPMorgan noted: “There is an obvious but worrisome read-across from Europe’s Covid-19 crisis to the US, given common threads of weak track-and-trace systems and lower levels of compliance [with social distancing restrictions] relative to some parts of Asia.”

03:07

France aiming for ‘brutal brake on infections’ with its second national lockdown to fight Covid-19

Although markets are influenced by many factors, the West’s botched handling of the pandemic – which has as much to do with poor preparedness as it does with indecisive leadership and coronavirus denialism – is now the most important one.

As I argued previously, lockdown fatigue in Europe and America poses a major threat to markets. Unlike in most parts of Asia, where success in suppressing the virus has allowed governments to sever the link between economic activity and the pandemic, Western economies are trapped in a vicious circle in which rising infections trigger renewed restrictions in the absence of a vaccine.

The US economy is on pace for a double-dip recession

This is as much a political problem as it is an economic one. Anti-lockdown sentiment is undermining the effectiveness of responses to the virus. In Britain, the party which forced the government to hold the Brexit referendum in 2016 is turning itself into an anti-lockdown movement, sensing an opportunity to capitalise on mounting opposition to this month’s shutdown.

In the US, the stronger-than-expected support for Trump in the election will make it more difficult to fight the virus. Tellingly, among the key swing states that Trump won, two of them – Florida and Ohio – have had some of the highest hospital admissions for Covid-19 over the past several days, suggesting that Trump’s anti-lockdown stance has significant appeal.

Investors are likely to become more discerning when it comes to asset allocation, favouring countries and regions where the virus has been brought under control and the recovery has taken hold. This is likely to benefit Asia, whose stock markets have outperformed those in Europe and the US since early September.

Indeed, sectors and assets in Europe and the US that are exposed to Asia’s economies are faring better. The clearest example is Germany, the only country in the euro zone to register an expansion in private sector activity last month, driven by a buoyant manufacturing sector that is benefiting from strong demand from China.

The failure to contain the spread of Covid-19 is costing Europe and America dearly. The longer it takes to develop an effective vaccine, the greater the risk that Western economies’ poor handling of the pandemic derails the incipient global recovery. A deeply polarised and potentially ungovernable America raises the stakes further.

Nicholas Spiro is a partner at Lauressa Advisory

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