investment insights
Does Europe’s second wave cast doubt on the speed of its recovery?
Lombard Odier Private Bank
Key takeaways
- European governments are imposing new measures to cope with a second pandemic wave
- While some impact on European Q4 2020 and Q1 2021 growth is inevitable, policy support remains in place
- In the meantime we remain constructive as economies recover, albeit more slowly.
- The short-term volatility may offer some opportunities to increase exposure to risk assets.
The pandemic recovery everywhere remains fragile and uneven. A second wave of Covid-19 infections is testing governments’ capacities to contain the public health fall-out and its economic impact.
The experience of the pandemic varies widely. Earlier this month, Chinese citizens made 637 million trips on trains and to tourist sites over the annual ‘Golden Week’ - the first national week-long holiday since January. Meanwhile the country’s economy continues to strengthen without lockdowns, and has significantly fewer infections than the rest of the world. China has recorded 710 new infections in the past month, and no deaths from the virus over that period. The economy is now getting back to full pre-pandemic capacity, according to our normalisation index (see chart 1). Following an effective containment, the country started rolling out its first vaccine in the middle of October.
More widely, the Asia-Pacific region should sustain global growth thanks to its pandemic controls (see chart 2). The success in containing the virus has boosted confidence, allowing a substantial easing of restrictions. Taiwan and South Korea have also recovered to their pre-Covid levels of output and sales. Industrialised Asian economies are now able to contribute to global demand and the region’s economies are proving best-positioned to navigate this pre-vaccine period and an eventual roll-out of a global Covid treatment.
The US, where the pandemic has killed more than 225,000 people, is still struggling to contain the virus. Infections in the US first peaked in April at around 31,000 cases on a 7-day rolling average, then spiked to reach 67,000 cases in late July. New cases are now being recorded at around 69,000 per day, according to the latest data. Covid-related deaths in the US, however, have declined. Mortality peaked on 18 April at a rolling average of 2,201 and on 24 October, the US recorded a comparable 800 deaths.US economic activity is 10-20% below pre-Covid levels. Meanwhile, the country is awaiting its 3 November elections. The first stimulus package was substantial, but lawmakers have so far failed to agree any new programmes.
In the 27-member states of the EU, reported infections in April first peaked at an average of over 32,500 over seven days. On 25 October, new cases had reached more than 156,000. In line with the US, mortality in the EU is also falling. On 10 April, the EU reported a 7-day average of 4,236 deaths. By 22 October, average daily deaths in the region had fallen to 957. In the eurozone, economic activity remains 10-15% below pre-Covid levels and governments are rolling out tougher Covid-19 measures including curfews to contain the pandemic in the run-up to the Christmas retail season.
European uncertainty
The public health situation across Europe is complex, and as everywhere, politically challenging to manage. In contrast to the widespread lockdowns of March, when confinement formed the first line of public health defence, lockdowns across Europe have now become an unpopular last resort.
“Stay in your home, where at all possible,” summarised German Chancellor Angela Merkel last week. Restrictive measures, including a six-month state of emergency in Spain, and curfews across France and Italy, are now in place.
The important difference with six months ago is that public health restrictions are regional, or targeted, sector-specific and time–limited.
Infections in this second pandemic wave have risen, logically, in line with increased levels of testing. This makes monitoring mortality rates and nations’ critical care capacity all the more important (see chart 3). Although the case fatality rate has declined compared with earlier this year, the use of many countries’ intensive care systems is rising again, and needs careful monitoring.
Without resorting to nation-wide lockdowns, health measures will inevitably affect European economic growth in the fourth quarter and potentially early next year.
Many European fiscal and monetary coping measures are already in place. Rather than reinventing new programmes, policies supporting incomes and businesses through the lockdowns and company and household credit can be quickly extended. In addition, European Central Bank’s monetary policy support for assets will continue. These measures should also include an accelerated final approval for the European Union’s EUR 750 billion recovery fund, with the first disbursements next year.
We do not believe, for these reasons, that there is a danger of reversing the economic progress made to date in Europe. However, assuming these measures are not prematurely pared-back, economies will not return to their pre-pandemic, 2019 levels of growth until the first half of 2022.
Impact on equity markets
Markets are reacting to the slowing pace of economic recovery and renewed public health measures. The strong relative performance in the eurozone equity market that we saw in September has therefore come to a halt with the resurgence of Covid cases. The consensus among analysts is that full-year 2020 earnings in Europe will fall by almost two-fifths compared with 2019, before recovering in 2021. For now, Europe’s markets still expect a sharp recovery in earnings over the year’s final three months. The risk for investors through the last quarter of 2020 is that any more restrictive public health measures, and resulting revisions to corporate earnings, would weigh on European stock markets.
We are aware of the risks that the second wave poses to the global recovery, as some sectors and regions continue to struggle with the pandemic’s consequences. But question marks over the pace of continued economic recovery in Europe do not mean that it risks running in reverse. While markets will inevitably suffer from short-term volatility, safeguards are in place in the form of monetary and fiscal stimulus. This should prove a strong support for risk assets, offering potential opportunities to increase exposure. In the medium term, we remain constructive as economies continue to recover, albeit at a slower pace. For now, the recoveries can only be partial, pending strictly respected public health measures and widely available vaccines.
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