Do European stock markets reflect current lockdowns?

Oct 27, 2020
While all eyes are fixed (literally) on staying up all night to follow the political situation across the pond, Europe continues to move in the wrong direction at a rapid pace in terms of Covid-19. With the virus now ‘running riot’, are equity markets pricing in the rising restrictive measures correctly?

There’s intense focus on the next evolution of the Covid situation in Europe and the potential crippling effect of new and prolonged national lockdowns on the growth outlook. Just when the reflation trade was gaining ground and consensus was looking forward to huge Biden-induced US stimulus, stock markets have instead been frightened. The German DAX finished October as one of the world’s worst performing equity markets, falling nearly 9.5%. Is there more downside to come?

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Lockdown 2.0

In the last few weeks, politicians across the bloc have started to tighten restrictions, keeping factories and construction open, while closing more service-oriented companies. These latest measures could lead to higher unemployment and the permanent closure of many businesses despite new government support, not to mention even more national debt.

That said, new lockdowns do not mean everything is closed with people more used to working from home and schools are staying open. This latter measure took a lot off GDP both directly and indirectly as parents had to take time off to look after children. But with the autumn and winter arriving in the Northern hemisphere, people are spending more time indoors which means the virus has better conditions to spread. Studies estimate transmission to be nearly 20 times greater indoors than outdoors, so despite the restrictions, the number of new cases rising further is highly likely. This has the potential to put health services under huge pressure once more as hospitalisations surge.

European engines under pressure

GDP is set to be hit once more by the new measures. Estimates suggest French GDP looks set to decline by 3-4% in the fourth quarter, while Germany’s ‘light’ lockdown should result in a drop of at least 0.5% quarter-on-quarter. Europe’s economic powerhouse has weathered the crisis relatively well to date in comparison with its European peers. In addition, China’s strong economic rebound should certainly help its export manufacturing sector which has outperformed the services industry.

Outlook well supported

Although some structural damage seems likely as second and third round effects begin to impact economies, a positive US election result may lift European equities in the short-term. Further out, bulls are hoping a deeper selloff is limited given the abundance of central bank and government support at hand, which should place a solid floor under markets. While a double-dip recession is increasingly being talked about, the hopes of a vaccine may also offset any prolonged selling as markets look to the new year.

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