Cumberland Advisors Market Commentary – The Second Wave of COVID-19 Confronts Western Europe

Author: William Witherell, Ph.D., Post Date: September 9, 2020
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The rebound in the European economies following the sharp fall in March and April is threatened by a second wave of COVID-19 cases. As a result of vacation travel and an easing of restrictions, case growth in Western Europe has returned to levels last seen in May, with 1,094,194 confirmed cases as of the end of August.

CA-Market-Commentary-The Second Wave of COVID-19 Confronts Western Europe

While disturbing, this statistic remains less than a third of the figure for the United States: 3,686,513. The Europeans did a far better job dealing with the first wave of the pandemic, which should make the second wave easier to manage. Also, recent cases are much younger on average than the cases in the first wave were, and hospitalizations have been far fewer. Thus, there should be less of a need for widespread lockdowns that would severely impact European economies.

It is the services sector that is likely to bear the brunt of new restrictions. The second wave of COVID-19 appears to have brought the services sector of the Eurozone almost to a halt in August. The Markit Eurozone Services PMI measure of services sector business activity for August declined from July’s robust 54.7 reading to just 50.5 which is close to the no-change level of 50.0. This decline reflects new restrictions on gatherings and movements, along with mask regulations, primarily at the local and regional levels, in response to rising infections, which have also affected consumer attitudes.

The Markit Eurozone Manufacturing PMI for August, 51.7, maintained the strong July reading of 51.8, indicating that industrial production is recovering sharply in the third quarter. Consumer goods production led the way, with the domestic sector being the prime driver. Export orders rose at a subdued pace. Since the services sector heavily outweighs the manufacturing sector, accounting for some 77% of Eurozone GDP, the large decline in the services PMI caused the Composite PMI to fall steeply from 54.9 in July to 51.9 in August. Thus, despite the strength seen in the manufacturing sector, the rebound in the overall Eurozone economy has come very close to stalling. The pressure is great on policymakers to proceed without further delay with announced measures to sustain the recovery, in particular, the EU 750-billion-euro Recovery Fund and seven-year budget plan.

The Eurozone equity markets, as measured by the iShares MSCI Eurozone ETF, EZU, remain down for the year-to-date September 3, by 5.67% on a total-return basis. This figure includes positive year-to-date returns for Germany and the Netherlands, but those have been more than offset by negative returns for France, Spain, Italy, Belgium, Ireland, Austria, and Portugal. Identifying the national markets with the best prospects within the Eurozone will continue to be important.

The latest activity data indicate that the largest Eurozone economy, Germany, and its neighbor the Netherlands have decoupled from Italy and Spain and also, to a lesser extent, from France. The Markit German Manufacturing PMI for August indicated that manufacturing production rose at the fastest rate in two and a half years, with a strong increase in new orders, accelerated growth in export orders, and increased business optimism. A slowdown in services, indicating a loss of momentum in the sector, caused the composite measure of business activity to lose some steam from July’s 55.3, to 54.4. Yet Germany’s August Composite PMI was the strongest in the Eurozone, well above France’s 51.6, Italy’s 49.5, and Spain’s 48.4, the latter two indicating declining business activity.

Germany has suffered less from the pandemic than the other four largest Eurozone economies have, with 251,650 cases and 9,330 deaths by September 4th. The corresponding figures for Spain are 498,989 cases and 29,418 deaths, while France has seen 347,268 cases and 30,730 deaths, and Italy has had 277,634 cases and 35,541 deaths. Nevertheless, Germany is among a number of European countries that are experiencing rising infections following the easing of most lockdown restrictions and the resumption of international travel in July. Germany has paused further easing of restrictions and tightened some existing rules that target infections arising from tourism and festivals and support the safe opening of schools. The objective is to avoid any broad lockdowns of business and society. In a major change to its traditional fiscal policy conservatism, Germany announced in June a 130-billion-euro economic recovery plan that includes direct payments to households and a cut in the value-added tax. Together with the fiscal stimulus to be provided at the European level and the monetary policy stimulus provided by the European Central Bank, the German plan should return the German economy’s growth to a healthy 6% annual pace next year.

The iShares MSCI Germany ETF, EWG, is up 2.8% year-to-date. The neighboring iShares MSCI Netherlands ETF, EWN, is up 4.1%. One factor accounting for this more favorable performance is the combined weight of technology and industrial sectors in these ETFs: 31.7% in EWG and 42.2% in EWN, substantially above their corresponding weights in other Eurozone equity markets. Germany’s and Netherlands’ manufacturing sectors are recovering strongly. Another factor is the relative success of these countries in dealing with the pandemic.

Private sector activity in France fell heavily in August as the Markit Composite PMI dropped to 51.6 in August from July’s robust reading of 57.3%. The Manufacturing PMI fell from 52.4 in July to 49.8 in August, very slightly below the 50.0 figure that indicates no change in the rate of activity. This decline follows moderate improvements in June and July. The decline in the services sector was greater, from 57.3 to 51.5, reflecting a broad stagnation in new business and demand.

France has in recent weeks recorded its highest number of daily COVID-19 cases since the spring, exceeded in Europe only by the spike in Spain. France reported almost 9,000 new cases on September 4th. In part, this figure reflects a dramatic increase in testing. It is estimated that the virus is actively circulating in 20% of France’s regions, where the local authorities have been asked to impose stricter rules on gatherings and movements. Masks are required on the streets of the Paris region and in communal workspaces. Fortunately, hospitalizations remain low, as recent cases are predominantly in younger people.

France’s President Emmanuel Macron has announced a plan to inject 100 billion euros of additional stimulus into France’s economy to boost growth at a time when the recovery is losing momentum and virus infections are rising. This plan, equal to about 4% of France’s GDP, aims at investment and structural reform, including a 20-billion-euro tax cut for French companies, 30 billion euros for reducing carbon emissions, and 35 billion euros for job protection, vocational training, apprenticeships, and hiring subsidies. The emphasis on industrial competitiveness and human capital rather than on demand stimulation should benefit the French economy over the medium and longer term.

France’s equity market was affected sharply by the pandemic and resulting shutdowns in the economy. The iShares MSCI France ETF, EWQ, has been recovering since March but is still down 10.0% year-to-date. If France is able to bring the current outbreak of virus infections under control, French equities should resume their recovery and may be able to reduce the gap between German and French stocks.

Italy’s manufacturing sector has made a dramatic recovery following the severe constraints on Italy’s economy due to the pandemic. In August, the Markit Italy Manufacturing PMI registered the best improvement in activity for over two years, with increases in output and new orders, but foreign orders declined. The encouragement in manufacturing was offset by services’ dropping back into contraction territory, bringing the composite PMI down below 50.0, to 49.5. The economy remains well below pre-COVID levels. Italy has had fewer virus infections but more deaths than Germany, France, and Spain have had. It is responding to the second wave of cases by imposing quarantines on travelers from Spain and Greece, closing nightclubs, and requiring masks between 6 pm and 6 am in public spaces if social distancing cannot be observed. The iShares MSCI Italy ETF, EWI, swooned when the pandemic struck and is still down 13.0% year-to-date.

Spain’s economy has declined in five of the past six months, according to the Markit August Composite PMI. At 48.4 it was at a three-month low, with services declining and manufacturing stagnating. It is not surprising that, as Markit reported, “sectors relating to tourism and social contact are suffering the most.” Spain has the highest count of COVID-19 infections in the Eurozone. The government was slow to act, and some of the messaging from leaders has been mixed. Spain has also had the largest number of second-wave cases, and its economy is likely to recover more slowly than other Eurozone economies as a result. Containment measures currently look very limited. The iShares MSCI Spain ETF, EWP, remains down a striking 20.0% year-to-date.

Cumberland holds the ETFs EWG and EWQ in its International and Global Equity Portfolios. The writer holds none of the ETFs mentioned in his investments.

Bill Witherell, Ph.D.
Chief Global Economist & Portfolio Manager
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