Head Research Analyst at Bovell Global Macro.

Is the European Recovery Stalling?

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The coronavirus continues to impact lives and our way of living across the world, but in the markets, it has taken a backseat recently. This week, however, it has come back into focus, especially in Europe where governments look to be losing control of the situation. New restrictions and shutdowns have the markets worried about the economic recovery.


Second Wave Hits Earlier Than Expected


As the coronavirus spread across the world earlier this year, governments were forced into shutting down their countries to slow the spread and ensure that medical facilities were not overwhelmed. For some countries like Australia and New Zealand, this worked to great effect. For the majority, there is no doubt that the lockdowns have worked, but the reopening strategies have largely failed. We saw this throughout the United States where the lockdowns were lifted prematurely and we are now seeing the same across Europe.


The issue is that governments have had to try and find the right balance between containing the virus and reopening the economy. Full national lockdowns earlier in the year saw unprecedented fiscal measures introduced. This included government backed loans, wage subsidies, payment holidays and so on. However, these types of measures are not sustainable in the long term. Furthermore, as scientists studied the virus, there was a general consensus that we would see a second wave during the winter months.


We are only in October and the second wave looks to have arrived a couple months early. In some ways it looks like it could be more aggressive than the first, particularly across Europe. European countries have been reporting record high case numbers in recent weeks. Some of this can be attributed to increased levels of testing and more effective tracing methods, but it is largely due to the reluctance of governments to reimpose full national lockdowns. Developments this week may force them to change their minds though, because hospitals are once again facing an influx of patients with hospital beds starting to run out.


Governments Struggle to Strike a Balance


Although the second wave of the virus in Europe appears to be less deadly than the first, there are still many people who are being forced into hospitals as they are experiencing severe symptoms. The spread also seems more rapid this time because of the reduction in restrictions. This means that hospitals are now starting to struggle, and governments are being forced into imposing restrictions.


In the UK, the government announced a 3-tier system earlier this week, with the highest tier forcing certain hospitality venues to shut. Meanwhile, curfews have been introduced across many areas in France including Paris. The German government has also hinted at new restrictions in the coming days, whilst the likes of Spain and Italy have already imposed new restrictions in recent weeks. These are some of the biggest nations across Europe, which has led to concerns in the markets about what will happen to the European recovery in the fourth quarter. Governments have made their decisions to tighten the rules, but they are now also under pressure to deliver further stimulus to support businesses and individuals throughout this period.


Q4 Projection Downgrades Incoming


The latest restrictions in Europe will likely lead to economists and analysts downgrading their forecasts for Q4. The more important question, however, is whether the recovery is going to stall. We have already seen the recovery slowing globally, which is broadly in line with expectations, but a stall in the recovery would be much more concerning.


The worst of the economic damage appears to be behind us in Q2, and although growth forecasts will be downgraded for this quarter, I expect the recovery to continue albeit at a slower pace. The risks are certainly to the downside and there is a risk of further restrictions being introduced. In the UK there is also active discussion of a circuit-breaker lockdown. Further tightening of the rules will add to the market jitters and put further pressure on governments to provide fiscal support. However, over the next twelve months, I would expect the recovery to remain on track.


If we look at a couple of the charts below, we can see that for both the FTSE100 and the EuroStoxx50, equities have not completed the recovery to the earlier highs of this year. In comparison, major US indices have formed new all-time highs. This is largely due to the fact that the US indices contain larger growth companies, whilst European indices consist of more value stocks. This presents a good opportunity to scale into some long positions in European equities in the coming months. Apart from the coronavirus, there is also the Brexit risk. If the EU and UK are able to strike an agreement, then this could be a particularly good catalyst to start building a position in European equities.


It is important to remember that the recovery will take some time so we do not need to rush into building a position, and we also want to leave enough breathing room for the position to go against us as this is a longer term play.


Chart of EuroStoxx50
Chart of FTSE100

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