Europe and the U.S. are going through another wave of COVID-19 pandemic outbreak. In Europe, many countries are facing record high infection numbers beyond the first wave in March/April. Momentum is particularly strong in Italy, France, Belgium, Czech Republic and Switzerland. In the U.S., the daily infection number has exceeded the peak in the summer. As a result, many governments are reintroducing social distancing and lockdown measures to control the spread of the virus. This has triggered concerns that these economies could dip back into recession.

While the infection numbers are hitting record highs in many of these countries, there are several encouraging signs. First, the percentage of COVID-19 tests that returned with a positive result has risen, but still below the peak in March/April. This indicates that the higher number of new infections is partly due to more tests available. Second, hospital admissions are also lower than the previous peak. Healthcare systems are better at screening those that need hospital treatments, versus patients with milder symptoms. Third, the mortality rate is also lower. Lower hospitalization and mortality rates are due to the infected group of patients being younger than the previous wave, but that trend is slowly changing with the older population’s infection rate also creeping higher. 

Not only are healthcare services more experienced at directing resources to those patients with the greatest needs, governments are also taking a more selective approach in their lockdown policies. Instead of a nationwide lockdown, most governments are trying to limit movement in cities or areas with the highest infection rates in order to reduce the economic costs.

As the pandemic is becoming more like a marathon, rather than a sprint, governments will need to be strategic in how they distribute fiscal resources to businesses and families. Regardless of policymakers’ strategies, more fiscal stimulus will be needed before the end of the year as Europe and the U.S. try to prevent their economies from falling back into contraction. In the U.S., it seems increasingly likely that this would come after the elections on November 3.

A weaker growth environment should not come as a complete surprise to markets, which have been expecting a sharp surge in quarter-over-quarter growth in 3Q 2020 for the U.S. and Europe, and returning to a more muted expansion in 4Q 2020 and 1Q 2021. One important question would be how this deceleration in recovery momentum would impact corporate earnings. 3Q corporate earnings in the U.S. and Europe have been encouraging, which might compensate for some softness in 4Q. 

EXHIBIT 1: MONITORING EUROPE AND THE U.S.

Source: J.P. Morgan Asset Management; (Left) European Center for Disease Control, U.S. Department of Health and Human Services; (Right) Johns Hopkins CSSE, The World Bank. Data reflect most recently available as of 20/10/20.

Investment implications

The pandemic continues to be the most important factor influencing the global economy and investment landscape in the next 12 months. The latest setback with regards to the pandemic in the U.S. and Europe is not a complete surprise as many medical experts have already warned that another spike would come when winter arrives in the Northern hemisphere. Nonetheless, the latest surge should push investors to take a more defensive position for the time being. In the very short term, the U.S. elections would reinforce this conservative bias.

This would imply room for more consolidation in global equities. While U.S. corporate debt, especially high yield and emerging market debt, have a positive correlation with equities, their high-income attribute continues to benefit from ultra loose monetary policy from developed market central banks. A loss of momentum in recovery simply strengthens policymakers’ case to keep stimulus coming.

In the longer term, the U.S. election results, regardless of the outcome, should provide the certainty that investors are constantly looking for. Meanwhile, as the outbreak becomes more contained due to social distancing measures, this should also restore investor confidence. We still believe that a sustained medical solution, whether a breakthrough in vaccine research, or a more efficient and cheap testing process, will help to facilitate the next stage of economic recovery, which would be constructive for global equities, especially those sectors which have been the worst hit by the pandemic.

In sum, we think investors should focus more on U.S. high yield and emerging market debt in the near term, while looking for opportunities to add to a diversified portfolio of equities in anticipation of a more comprehensive global recovery in 2021. 

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