John Authers

Covid Fear Is Back in Markets, and It's Global

Volatility is back. Monday saw the VIX index, which tracks how investors spend to hedge against volatility in options markets, jump above 30 for the first time since the brief but violent correction for FANG stocks in early September. That correction was very much internally generated, as a buildup of speculation through call options forced investors to buy tech stocks. This incident is somewhat different:

This time around, the market is responding to a clearer external threat. The Covid-19 numbers aren’t good. There is good reason to question whether the headline numbers are misleading, but that didn’t negate the psychological impact of new cases in the US topping their record from the summer wave in the Sun Bel.

People testing positive now are far more likely to survive than they were in March or April, and the death rate continues to decline. But statistics on hospitalization make clear that the disease is meaningfully recurring, in a way that cannot be dismissed as an artefact of more testing. In terms of numbers hospitalized, the US is plainly in a third “wave.”

The problem is greater in Europe, where even Germany — the most successful major European country in dealing with the pandemic so far — is seeing a rise in hospitalizations. In Germany’s case, this is only a second wave, which remains much smaller than the first. But the problem is the direction of travel, which is plainly seeing the pandemic having a greater effect again.

Crucially, this means that the disease is once again creating more economic damage, in the US and western Europe. That is what matters for the market. A chart of economic activity in Germany, produced by Longview Economics in London, shows that the country had almost returned to normal for the time of year, but is now slipping significantly.

Combine all this with scary news, such as rash of infections in the US vice president’s office, and a curfew in Paris, and it isn’t surprising that the market reacted. As if on cue, the “Covid fear” index, which shows the relative performance of the S&P 1500 food retailers sub-index compared to the S&P 1500 hotels resorts and cruise lines index, jolted back upward on Monday.

The hotels index had its worst day since June. Food retailers have once again outperformed by a full 100% for the year. This suggests it is the immediate fear of direct disruption from Covid-19 that is moving markets.

There is still nothing to suggest that investors think they need to brace for an economic shock as severe as the one that hit in the spring; the last seven months have taught everybody how to stay active in time of coronavirus. But Monday’s market behavior can be seen primarily as a belated move to account for the growing risk from Covid.

This is a discriminating virus. In the corporate world, the identity of its worst victims, and of those who survive unharmed, can be surprising. No sector has been worse hit than travel, leisure and tourism, for obvious reasons. The US hotels sector is down 40% for the year. Globally, the hotels, restaurants and leisure sector is still down by 10%. But there is great variation within the leisure sector. Remarkably, the S&P 1500 restaurants sub-index has outperformed the S&P 500.

Generally, the larger quoted US restaurant chains aren’t reliant on inside-dining. By moving to curb-side pickup and beefing up their delivery options, they may even have benefited. And presumably there must be high hopes that they will eventually displace smaller inside-dining operations altogether. Renewed lockdowns might deliver the coup de grace to expensive restaurants, or to the whole concept of eating out.

Still, a lot of hope is embedded in the price. It’s not so long since restaurants traded at much the same price-sales multiple as the S&P 1500 as a whole. Restaurants were already perceived to be worth a big premium even before Covid-19 hit. Now, their sales multiple is double that of the market. Some interesting bets on changes in consumer behavior after the virus are already being made.

Return to Chile
Almost exactly a year ago, Chile suddenly and dramatically descended into chaos. People took to the streets throughout the country, a skyscraper in Santiago was set alight, and within days the country’s president had had to agree to hold a referendum over establishing a new constitution. The current one was written under the dictator Augusto Pinochet, and Chileans, chafing at inequality, had had enough of it.

After a Covid-driven delay, that referendum finally took place at the weekend, and delivered an emphatic vote for reform. The country will now spend much of the next two years drawing up a new constitution.

The whole story has faded from memory in the northern hemisphere amid the drama of 2020. But the prolonged political uncertainty has had an impact. Chile had previously been known for its stability (starting with a remarkably peaceful transition from dictatorship 30 years ago), and the protests came as a shock.

Normally, Chilean share prices move broadly in line with the price of copper, its main export. This year, copper has staged a big rally, which is usually enough for the Andean economies to lead the emerging markets for a while. The opposite has happened.

In practice, it is hard to see this changing for a while. There is another moment of uncertainty next April, when Chileans will vote for delegates to a new constitutional assembly. Then it could take a year to write the new document, which must be agreed by two-thirds of delegates. The likelihood is that any new constitution will be much less market-driven than the neoliberal model adopted by Pinochet. Chile’s market performance over the last year shows that much political risk is already priced in. But it will still be a while before clarity can be achieved.

Everyone should watch carefully what transpires, because the economic model established under Pinochet was much admired and copied, in Latin America and beyond. Chile’s pension system is now the center of popular anger, and yet for decades it was taken as a template for a series of countries embarking on welfare state reform. The problems for Chile’s system will likely recur to a greater or lesser degree in other countries that adopted a defined contribution system of pensions.

Just as a reminder of what might be at stake, I will quote again one email I received from a Chilean woman who had had enough of the unfairness of Chile’s welfare state:

“Truth is that people are tired of working 40+ years and putting their retirement money into programs which take 10% each month, just so when you finally retire they give you approximately $200 a month which is not enough to finance the cost of living in Chile . And you might say "hey, but why don't they just get their whole ton of money they saved?" No. They can't. Even if someone has a terminal cancer they will not give them the whole amount of money saved because that's not how the system works...

“When our politicians get $11,000 a month but our minimum wage is $469 approximately, which is what most of the country gets a month, that inequality is violent. When our politicians pass laws to raise their wage in less than a week, but laws to have a better health plan and release money for medical supplies take months and months, that's violence.”

None of this should lessen the nation’s achievement if it does manage to continue its transition from dictatorship. Such changes are seldom made this peacefully. But the experience should be a reminder to investors the world over. It may well be healthy for much of the rest of the world to move to a more egalitarian model that people recognize as fair. That is what the populist movements around the western world plainly want. And it is always best to avoid bloodshed. But such transitions are unlikely to be made without a negative hit to the value of stocks and bonds.

Survival Tips
Let's return to Chile. It's the elongated country that gave the world the poet Pablo Neruda. To enjoy the genius of Neruda and his effect on those around him, you might try Il Postino, a wonderful movie from 1994 that infuriatingly doesn’t appear to be on any of the main streaming services at present. This scene gives an idea of the impact his words can have; the plot is that Neruda, in exile, helps a shy postman to win the girl of his dreams by writing poems for him.

The poetry loses much in translation, but there are still ways for those who don't speak Spanish to appreciate it. This is a beautiful reading of one of my favorite Neruda poems, Leaning into the Afternoons, which handily comes with subtitles. Or you can try listening to a snippet that I found on the internet of a setting of this poem by the American composer Matthew Harris. To declare an interest, this is a recording of the premiere, and the work had been commissioned by the choir I was singing in at the time, Cantori New York. It's a very sweet piece and I hope you like it.