Analysing the next stage of the Covid crisis on stock markets

We are entering a new phase for financial markets’ reaction to the coronavirus crisis. This new phase is defined by two drivers, firstly, earnings reports from the world’s biggest companies, and secondly, pressure on governments around the world to publish plans on how they will end the global lockdown and plan a return to ‘normal’ life. Below we take a look at three factors that could drive markets in the short term.

1, Earnings 

We have already published a comprehensive review for the Q1 earnings season which we would urge you to read, however, there are some points that are worth making in this article. The recovery in stock markets that took place from 23rdMarch may have ended earlier this week. The ‘recovery’ was based on technical factors- such a sharp equity market sell-off had to end at some time and a 40% fall for some major equity indices seemed like a decent buying opportunity. However, traders who joined in this ‘recovery’ rally were doing so blind. Stock market performance has been notably worse in the last 24 hours, potentially on the back of the biggest earnings reports so far. Some US banks have reported a decline in earnings, for example JP Morgan, and have issued forward guidance with a very negative tone. We expect this to be followed by many other companies, particularly in the energy, automobile, housing and retail sectors. Looking ahead to the next few weeks, we expect markets to struggle to rally on the weight of negative forward guidance and the reality of the economic damage wrought by Covid-19. 

However, there could be some respite for the bulls, any unexpected good news from the corporate world may be richly rewarded by investors. We are particularly interested to hear from Facebook and Alphabet, to see whether a massive increase in screen time and social media usage has protected precious advertising revenues. If it has, then we could see a shorter and less severe second wave of selling in the stock market. However, we expect traders to be quick to react to earnings news, so it is worth keeping a close eye on it if you are trading in the coming weeks. 

2, When will lockdown end?

This is the key question being asked by societies around the world – when will life return to normal, and will it return to normal in. stages? This is a key unanswered question for traders this week and it is one reason for the negative performance of major stocks market indices, the FTSE 100 is down more than 3% on Wednesday. The prospect of an end to lockdown sometime around the end of April or May, is one reason why stock markets seemed to have made a decent bottom at the end of March. However, the UK and the US continue to see their infection rates and death rates grow at fast paces, suggesting that these two major nations have not yet reached the peak in their coronavirus cycles. This suggests to us that lockdown is unlikely to happen for the next few weeks. With the UK’s lockdown expected to be extended for another 3 weeks, there is a chance that it may take another few week’s after that before it is lifted. When lockdowns are lifted the expectation is that they will be lifted slowly, so there will not be a single date to work towards when global economies are back firing on all cylinders. 

At this stage, governments around the world are loathe to mention an end date in case it makes their citizens complacent. This is undoubtedly causing a chilling of risk sentiment this week. However, the alternative could be worse. While lockdown is terrible for the global economy, what would be worse is an end to the lockdown too soon leading to a second wave of cases, and a second lockdown. In that event we could see risk assets free fall. Thus, while analysts and traders are all waiting anxiously for exit strategies to be published by governments around the world, we must remember that a misstep at this stage could cause much worse economic damage and spook financial markets once again. 

3, Politics 

The souring of sentiment towards risky assets in the middle of this week also corresponds with growing criticism of Western governments over their handling of the crisis.  In the US, President Trump had an unprecedented press conference where he lambasted reporters for spreading fake news about his handling of the crisis, in the UK the government is coming under attack for not providing enough PPE for health care workers. In Europe there is an existential crisis growing about whether hard-hit countries like Italy should borrow money to pay their own way out of the pandemic, or if debt should be pooled (right now it’s the former, albeit lending at very favourable rates). On top of all of this, virtually all countries in Europe are coming under attack for how they are dealing with patients in care homes, where Covid can have tragic consequences. The result is a lot of negative press around how the West has handled the crisis, at the same time as the West is facing one of its largest ever economic challenges. The combination of negative politics and economic destruction could prove toxic for stock markets and risk appetite and it is one of the reasons why stock markets are falling on Wednesday. 

We believe that President Trump and the White house’s strategy for combatting the virus is likely to be causing the most fear for investors, especially after news on Wednesday that the Trump administration was suspending funding to the World Health Organisation. In this environment, investors crave certainty and predictable behaviour. The US administration is not doing that, and it could have a negative impact on risk sentiment around the world.  

Thus, you have a trifecta of risk factors that could weigh on stocks in the short to medium term and dent any recovery in market sentiment. This is no time to take your eye off the ball, as market trends may not last. Short-term trading strategies with a strong focus on risk management could save your trading skin in this environment.