HONG KONG: European stocks, a chronic underperformer in global equity markets, are having a great year. The Stoxx 600 index, the leading gauge of European shares, is up 13.5 per cent since the start of 2021, on a par with the technology-heavy Nasdaq Composite and not that far behind the benchmark S&P 500.
Yet, on Monday, the Stoxx 600 suffered its worst day this year, tumbling 2.3 per cent due to mounting concerns about the rapid spread of the highly transmissible Covid-19 Delta variant, said Nicholas Spiro, a partner at Lauressa Advisory.
Other major stock markets also suffered sharp declines, whille the Vix index of equity market volatility, often referred to as Wall Street’s “fear gauge”, surged 22 per cent.
“The pandemic – which devastated the global economy but has had a negligible impact on investor sentiment due to the unprecedented stimulus measures taken to counter the fallout – has been a persistent thorn in the side of markets amid concerns about the strength and durability of the recovery.
“While the vaccine breakthrough last November provided a major fillip to sentiment, outweighing concerns about lockdowns in Europe and the United States, the surge in the Delta strain across the globe comes at a time when the medical response to the pandemic is under intense scrutiny,” Spiro was quoted as saying by the South China Morning Post.
That new cases are rising exponentially even in countries where vaccination rates are relatively high, such as Britain, is cause for concern.
Far more troubling, however, is the failure to sever, or at least weaken, the link between infections and severe health problems in countries with low vaccination coverage, several of which are in Asia, the region previously seen as the most successful in combating the virus.
According to Spiro, it is not difficult to see how the spread of the Delta variant – and the emergence of other infectious strains – could exacerbate concerns about global growth and corporate earnings, causing a sharper deterioration in sentiment.
“Yet, the disconnect between the threat posed by the pandemic and the key factors supporting asset prices remains powerful, and is unlikely to weaken sufficiently to trigger a major sell-off.
“Indeed, in Bank of America’s latest fund manager survey, published on July 13, the virus did not even figure in the top three ‘tail risks’ cited by respondents,” he said.
Over the past 18 months, the pandemic has been more of an irritant than a major headwind for markets. Even before vaccines helped weaken the link between infections and serious health threats, Spiro noted that asset prices were influenced more by aggressive stimulus measures and expectations of a strong recovery.
In the second half of last year, the MSCI World index, a gauge of stocks in developed economies, surged more than 20 per cent despite a brutal resurgence in cases in Europe and the US that led to the imposition of lockdowns.
By mid-August, nearly three months before the vaccine breakthrough, he explained that the S&P 500 had already surpassed its pre-pandemic high, turbocharged by a virus-induced rally in tech stocks.
Spiro said: “If markets were not unduly concerned when hospitalisation and death rates in advanced economies were at their highest levels since the pandemic erupted, it is unlikely that the Delta-driven outbreaks – which so far have not caused a surge in hospitalisations and deaths in countries with high vaccination rates – will be the catalyst for a sharp sell-off.
“The pandemic’s importance in shaping sentiment lies only in its ability to accentuate concerns about the pace of growth, especially in the US and China. The unravelling of the reflation trade – which predates the emergence of the Delta strain as a source of volatility – has been the overriding driver of markets in recent months.”
He cautioned that excessive optimism about the sustainability of the blistering pace of growth is coming back to haunt investors.
Cyclical stocks, which are highly sensitive to the economic news flow, have been suffering for some time. A gauge of US transport shares is down almost 8 per cent since early May, with airline stocks experiencing the steepest declines, Spiro said.
The sudden shift in bond markets, which only a few months ago were fretting about inflation, has been even more dramatic.
Although numerous factors are at play, signals from the US Federal Reserve – that it will be less tolerant of stronger-than-anticipated price pressures than previously assumed – outweigh pandemic-induced fears about slower growth.
“Indeed, with global stock markets still trading near record highs, it is hard to get too alarmed about the Delta variant.
“While lofty valuations pose a significant risk, and the threat of a policy mistake by a leading central bank is a real concern, the fears about a sharp slowdown in growth that are gripping markets look overdone.”
According to Spiro, investors were still worried that a premature tightening in monetary policy would derail the recovery a few months ago.
Now, however, expectations about when the Fed will start raising interest rates are being pushed back, lending support to equity markets.
The Delta variant is not the main determinant of sentiment, said Spiro. “Yet, by contributing to worries about growth, it is at least allaying concerns about overheating in the US, a major risk earlier this year.”