Covid-19: Breaking it down for the summer
By Shaan Raithatha, economist for Vanguard Europe.
Financial markets are forward-looking. It is why there may appear to be a disconnect between the dreadful economic data currently being published (which captures the past) and the degree to which asset prices have been holding up.
Given the sharp contractions in economic activity we are observing, the threats of secondary Covid-19 outbreaks and growing numbers of infections globally, it’s fair to say that a significant number of investors seem relatively hopeful about the economic road ahead.
But the spread of Covid-19 doesn’t affect all sectors of the economy equally. Those industries that require a more personal touch are much more vulnerable than those that can operate well despite the social distancing measures in place. This is reflected by markets with some sectors faring better than others, highlighting the evergreen benefits of a suitably diversified portfolio.
FTSE World Index total returns year-to-date by sector
Past performance is not a reliable indicator of future results. Source: Bloomberg. Period covered is 31 December 2019 to 23 June 2020. Total return includes dividends reinvested.
One of the most important factors determining the extent of the contraction in economic output is the strictness of each government’s lockdown measures. We can see this by plotting the yearly contraction in industrial production and retail sales in April against a measure of how strict the lockdown was during that month, as measured by the Oxford Covid-19 Government Stringency Index.
How lockdowns have reduced activity
Source: Oxford Covid-19 Lockdown Stringency Index, Bloomberg, Vanguard calculations
And unsurprisingly, that correlation is strongest in those areas of the economy that rely most on human interaction. Retail and recreation is a case in point. As the table below illustrates, this is showing signs of renewed life across Europe and should continue to pick up as lockdowns are eased.
How economic activity is picking up
Source: Google Mobility Data. Data period from 22 March 2020 to 14 June 2020. Notes: Google Mobility Index: Retail and Recreation, 7-day rolling average. Mobility trends for places like restaurants, cafes, shopping centres.
However, we’re still not at pre-virus levels in most of these countries. Germany, France, Italy and Spain are experiencing activity between 10 and 30% below the levels reached in February. And in the UK and Ireland, where lockdown restrictions are stricter, activity is 40 to 50% lower. The shock to demand is expected to dissipate very slowly as the consumer ‘fear factor’ persists.
And this dovetails with a recent poll from YouGov, which suggests that many consumers will still be reluctant to commit to a host of activities for the foreseeable future, even after the 4th of July, when lockdown measures ease further.
Lingering fear factor
Source: YouGov survey conducted on 2-3 June 2020 on 1709 adults in the UK
So as temperatures pick up across Europe and borders reopen, it highlights the limitations that could hold up other key industries, notably tourism and travel. In this respect, countries like Portugal, Greece and Spain but also Italy, with their relatively large tourist sectors, evidently have most to lose.
Financial markets are rightly looking ahead to the economic recovery and the improvement in business conditions that it will bring. Even so, we expect demand will take longer to recover than supply due to lower incomes and a lingering consumer reluctance to participate in perceived risky activities.
In addition, the risk of a second wave of infections looms large and may prompt further local, or even national, lockdowns in the future.
Given the large degree of uncertainty inherent in the outlook, we expect short and sharp spikes in volatility over the coming quarters. Investors may be able to capitalise on these periodic episodes of volatility. Attractive opportunities are likely to arise, particularly as the Coronacrisis will not affect all asset classes, sectors and regions equally.
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© 2020 Vanguard Investments Switzerland GmbH. All rights reserved.