Analysis

Here’s what it’ll take for markets to stop worrying about Covid-19

The biggest driver of markets over the past 18 months has been fear of Covid-19. And right now it's back in the ascendancy, says John Stepek.

I mentioned yesterday that “Freedom Day” might well be accompanied by a suitably ironic market reaction.

It was – and not just in the UK. Markets around the world took a knock.

So what’s going on? And what might it take to turn this around?

Fear of Covid is dictating the market mood

We live in a time where people are far too accustomed to markets going up absolutely all  the time. So it’s easy to get hyperbolic when the world’s stockmarkets drop off by anything more than 1% in a day.

However, it’s fair to say that yesterday was a rough day for markets. Stocks in Europe had their worst day this year, while in the US, the S&P 500 fell by 1.6%. Meanwhile, crude oil tanked – Brent fell by about 7%. Even by oil’s relatively volatile standards that’s a chunky drop.

More importantly, investors piled into government bonds. Yields fell to lows we haven’t seen since early this year. That is not a sign that investors are fretting about inflation. That’s a sign that they’re worried about the opposite.

You can overthink all this stuff. But as we discussed yesterday, it’s pretty clear what’s been driving markets for the past 18 months to two years – it’s all about Covid-19.

When we realised it was serious, markets crashed. When central banks and governments pulled out the stops in March and we thought it might be all over bar the shouting come summer 2020, markets rebounded.

When the second wave kicked in in autumn, markets lost momentum. When vaccines were announced in November, they rocketed again.

They lost some steam earlier this year, again having priced in the surge in inflation. And now we’re back to fear of Covid meaning that we’re worried that a) inflation really will be transitory, because growth will end up being stifled for much longer than expected; and (I think this is an under-estimated factor) b) that central banks and governments won’t have the same political or financial latitude to save it.

So I suppose that means the important thing right now is: will we ever get this damn virus under control?

The two things that really matter when it comes to Covid statistics

From a Covid-19 point of view, this is fundamentally about the effectiveness (or not) of vaccines.

It’s easy to lose clarity when we’re thinking about the pandemic. There are so many opinions, lots of them motivated more by politics (of all varieties) than by science.

And I don’t know how you’re feeling, but I don’t mind admitting that I’m well past the point of finding all of this somewhat frustrating. I want this cloud to be lifted and I’m sure you do too.

But parking all the noise about vaccine passports and fights about mask wearing and the fairness or otherwise of various financial anti-coronavirus measures and epic levels of mission creep on the behalf of various institutions, fundamentally only two things really matter here.

One is the number of people getting Covid badly enough to end up in hospital; two is the number of people dying of Covid.

Most people are not going to get Covid. That was true even when it broke out. Lots of people who do get Covid will only get it mildly. That was true even when it broke out. But enough people got very ill and enough people died to make it an emergency.

What we need the vaccines to do now is to prove that they can keep the latter two numbers to much smaller levels. If that’s shown to be the case, then we should be able to (fingers crossed) accept that we’ve found an effective solution to the virus.

That would take a lot of heat out of the politics of it all. If people feel confident that it’s beaten, then both the full-on “zero Covid or you can never leave your house again” brigade alongside the “Bill Gates wants me for a sunbeam” mob will retreat to the fringes of argument where they belong and the rest of us can get on with things.

And from the point of view of investors, it would plug a big hole in everyone’s confidence.

This rather makes the UK the ideal testing ground. We have a heavily vaccinated population (especially at the vulnerable end of the age range) and everyone is being tested to within an inch of their lives.

However, the UK isn’t the only one that can give us an indication. Israel recently re-imposed some Covid restrictions having previously opened up. But while hospitalisations (according to Our World in Data) have risen a bit, deaths have barely budged (fluctuating between one and zero on a daily basis) and in all it looks nothing like the previous surges.

It seems to be a similar story in the UK (and bear in mind we’ve just had some massive super-spreader events in the form of a big and unusually exciting football tournament, so that’ll be an added acid test for the next month or so).

Of course, there are plenty of countries – most of them in fact – where vaccination rates are nothing like as high in the UK. And anti-vaccine sentiment is, if anything, unusually low in the UK, so there’s an element of that to contend with as well.

But if it becomes clear that vaccinations work, and that they enable re-opening, then you have to believe that at some point we can put an end to the stop-start re-opening of the economy. If that means everyone wears masks on public transport for a while then that’s not really important – the key is for us to be able to go about our business.

So in all, my base case scenario is that markets will eventually – and realistically we should have a good view within the next couple of months – swing back towards a belief that Covid is beatable. Chances are they’ll then start worrying about inflation again.

But we can cross that bridge when we get to it.

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