There are several dark clouds gathering over the stock market, but UBS warned this week that this overlooked situation “is the single biggest near term risk” to the market. Here’s what you need to know now.
With the upcoming presidential election in the U.S., many investors are worried that election chaos could crash the market.
But UBS said this week that there’s another “major downside risk” that’s more likely to crush stocks.
“Forget about the U.S. elections or fiscal stimulus – restrictions creeping higher is the single biggest near term risk to the outlook,” said UBS economist Arend Kapteyn in a note, referring to rising movement restrictions amid a second wave of the coronavirus in the U.S. and Europe.
“If countries start to impose ‘circuit breaker’ lockdowns that last just several weeks, that may already be enough to turn a positive (fourth quarter) growth rate negative,” Kapteyn continued.
“Circuit breakers” is a term coined by scientific advisors to the British government who have recommended two- or three-week “mini lockdowns” in COVID-19 hotspots, with the time-limited restrictions designed to act as a “circuit breaker” to the infection rate, as the name implies.
Northern Ireland was the first to announce a “circuit breaker” lockdown, which began on October 16 and will last for two weeks, while Wales announced a similar lockdown that will go into effect on Friday and last until November 9.
In the U.S., coronavirus hospitalizations are rising in 37 states, with Alaska, Iowa, Kentucky, Montana, Nebraska, Oklahoma, South Dakota, Utah, Wisconsin, and West Virginia all hitting record high averages in hospitalizations this week.
“What’s concerting here is that it’s only mid-October and there is a long fall and winter” ahead of us,” said Isaac Bogoch, an infectious disease specialist and professor at the University of Toronto. “We are clearly in the second wave in many parts of the Northern Hemisphere and we really need to have more control of this infection at the community level. We know exactly what it’s like when health-care systems are spread beyond capacity. We saw that in New York City. We saw that in Houston. We saw that in many other parts of the United States.”
Elsewhere in Europe, France and the Netherlands have both tightened measures in recent weeks, Kapteyn wrote. UBS has been tracking mobility restrictions due to the coronavirus pandemic in 42 geographies weekly since March on a scale of one to 10.
And according to the firm, if lockdowns increase by one point for an entire quarter, gross domestic product will decline by 6 percentage points.
The U.K. and the Netherlands have increased from a “moderate” rating of 2.5 to an “intermediate” level of 5 over the last month. UBS has also raised the Czech Republic’s score by 2 points to 4.3, and Ireland and France by 1.5 to 4.5.
The median level of restrictiveness is 3.5, which is up from August but still down from 8 in April as much of the world was shut down in an effort to stem the spread of the virus.
“However, the number of countries taking measures has been increasing,” Kapteyn said, with 13 economies increasing restrictions last week.
“We’ll need to monitor how long restrictions stay in place and how mobility responds, but this is now a major downside risk to our forecasts for (the fourth quarter,” Kapteyn added.
While mobility restrictions due to the coronavirus pandemic may be the biggest downside risk to the market, election fears remains a significant risk.
And Morgan Stanley chief U.S. equity strategist Mike Wilson said this week that there’s a good chance markets could drop before the election, presenting a buying opportunity.
Wilson also warned that investors have recently grown complacent about the risks of a drawn-out legal battle to determine the winner of the election between President Donald Trump and Democratic presidential nominee former Vice President Joe Biden, which would undoubtedly push stocks lower.
“If the S&P 500 were to go down to 3,100 index points and we didn’t know what was going on with the election yet, we’re going to be adding to risk at that point no matter what,” Wilson said.
Why? Because, according to Wilson, no matter who wins the election, it’s almost certain they will unleash more economic stimulus to boost the economy, which should drive asset prices higher.