It seems that the full lockdown phase of the Covid-19 crisis is drawing to a close.
In the UK, we’re being gradually let off the leash. The same is happening to varying extents in various states across the US and countries in Europe.
In China, of course, and other areas where the virus hit first, lockdowns have been over for a while. So what happens now?
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Three big risks for the market right now
It’s not clear how the end of lockdown will go. South Korea, for example, is shutting down parks and art galleries and the like for the next fortnight because there has been a spike in cases. That said, a stop-start return to economic normality is still a step in the right direction. And it’s important to wrap your head around this.
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Markets don’t need things to be perfect. They just need things to be getting better than they were. This is why you can have an awful economy and a resurgent market. The market can’t predict the future (no one can), but it does look to the future. So it’s not about how bad today is, it’s about whether tomorrow looks worse or better. And for the time being, tomorrow looks better.
Of course, at some point, the market’s expectations shift to the level where a better tomorrow is entirely priced in. And before much longer, you get to the point where the market is over-optimistic.
This is probably the risk of where we are now, or at least, specifically in the US. Markets have rebounded pretty strongly since the low in late March. Looking at it in a very “big picture” way (ie, I’m not paying attention to individual markets or sectors – some of which still look cheap), I can see that sentiment could be vulnerable to a knock, at least in the short term.
There are probably three things that could cause trouble. One is that the end of lockdown goes badly: maybe we get more outbreaks; maybe we realise that it’s one thing to end lockdown and quite another to get people moving again; maybe something entirely unexpected happens.
The second is that all the market plumbing might get a bit clogged. A lot of government debt is being issued. Central banks are going to have to stay on the ball to make sure it all gets digested smoothly. I’m sure they are keenly aware of this fact but there are a lot of moving parts here and I imagine it’s easy for glitches to occur during the process as market expectations change.
The third is that investors might start to pay attention to all the other genuinely worrying things that are happening. The deteriorating relationship between the US and China is one obvious example. Indeed, it's one of the few things that has garnered any news coverage at all between all the Covid and Cummings headlines.
Donald Trump is conducting a press conference later today which will give us an idea of the US reaction to China’s moves on Hong Kong. Depending on what he says, that could spark a big shift towards a “risk-off” mood (or maybe not, we’ll see what he comes out with).
Closer to home, Brexit is another side issue that has managed to eke out a little bit of airtime in recent weeks. You can expect the usual hardball discussions to be taken at face value even after all these years of bluff and counter bluff. And you can expect the pound to react to each and every eyebrow twitch.
My usual advice: stick to your plan
What does this mean for you as an investor? I’m going to repeat what I've said many times before: stick to your plan. We’re not trying to second-guess the market here, we’re just trying to think about potential scenarios to avoid panicking when and if they arrive.
A very large part of investing (assuming you are trying to manage your money in any sort of active manner) is keeping a grip while everyone else appears to be losing theirs. That’s why it’s useful to think about these things.
It’s also useful because it means you can spot where there are blindingly obvious opportunities during market panics. However, we’re not in that stage now.
I’m not saying that I think we’re going to have another crash, because I don’t. I’m just saying that it feels like the risks are now a bit more balanced – the initial rush to bag a bargain is over, and we probably require a bit more clarity on the path of the recovery to get another big surge in FOMO (fear of missing out).
In the longer run, I do think that the “melt-up” scenario is more likely than another “meltdown” – but it’ll happen on the road to an inflationary endgame. And on that point, make sure you listen to Merryn’s latest podcast interview, with James Ferguson, founding partner at the MacroStrategy Partnership and regular MoneyWeek contributor.
The first half takes a critical look at the Covid-19 lockdown strategy – but if you’re fed up with Covid, jump to the second half (about 25 minutes in) in which James looks at why inflation is an under-appreciated risk. Moreover, he explains why it’s an issue this time, whereas during previous periods of quantitative easing, it hasn’t been. You really need to listen to this.
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