Covid Isn't the Only Big Fear for Investors

Marcus Ashworth
·3-min read

(Bloomberg Opinion) -- European shares have been pounded in recent days because of the tightening of lockdown restrictions in places such as France and Germany. The latter has suffered especially badly in the markets. The last eight trading sessions have wiped more than 10% off German equities.

Understandably, investors are banking profits after a stellar run for the Dax index. It has been the best performer in Europe this year — up more than 50% since the March lows of the first Covid wave — driven by a resumption of exports to a resurgent China.

But there is another contributor to the recent dip in European stock markets. While things do indeed look bleak again for the region’s leading economies, this drop is also being driven by a global de-risking by investors ahead of next Tuesday’s U.S. election.

European bond markets aren’t reacting with quite the same concern. The havens of German and French bonds are barely changed in yield despite Wednesday’s announcement of effectively a second lockdown in both countries. Italian and Greek yields, though, are higher, along with riskier euro corporate junk bonds.

So this isn’t a classic flight-to-quality (sell stocks/buy bonds) market reaction, and that’s not unique to Europe: The global benchmark yields of U.S. Treasuries are also little changed, despite a tech-led equity selloff. Other havens such as gold and Bitcoin are giving up gains. It seems cash might be the preferred option for some in such febrile days.

At the back of all traders’ minds is the risk that this could be a contested election result or a drawn out conclusion like the 2000 “hanging chad” vote. A prolonged delay would probably bring carnage to the markets, pushing the dollar and equities sharply lower. Top-quality bonds are already priced for maximum alert at super-low yields, which may explain why they’ve moved so little in this precautionary stock selloff.

Volatility trackers are already pricing in rising risk levels, with the CBOE VIX index of S&P500 stocks jumping 50% in the past week. The Eurostoxx 50 V2X index is close behind. The bleak scenario of a contested election may not unfold but there will be no prizes awarded from risk managers for traders taking unnecessary gambles ahead of Tuesday.

None of this is to downplay the seriousness for investors of the pandemic in Europe. It has equal billing right now with the future of Donald Trump. The continent’s share indexes are weighted more to Covid-affected sectors than their tech-heavy U.S. counterparts. Euro area economic data are also moving downward. Spanish unemployment is now 16.3%, with young joblessness topping a staggering 40%. The euro zone PMIs for services have fallen back below 50, reflecting the new closures of restaurants and bars. Deflation looms.

Unfortunately, the European Central Bank may not react in any meaningful way at Thursday’s governing council meeting, bar signaling that further stimulus is highly likely. It’s unclear what the purchase of perhaps another 500 billion euros of negative-yielding bonds will achieve. The European Union’s 750-billion euro Recovery Fund (still not ratified) is already looking insufficient, especially as Spain and others will balk at the conditions.

Until the U.S. presidential race is settled European equity investors will think twice about jumping back into the water. Next week’s vote is critical for all of us.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Marcus Ashworth is a Bloomberg Opinion columnist covering European markets. He spent three decades in the banking industry, most recently as chief markets strategist at Haitong Securities in London.

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