Commentary on Political Economy

Wednesday, 18 November 2020



Markets Can't Avoid the Reality of a Dark Winter

The closure of New York schools has brought home the heavy toll that the resurgent pandemic is likely to exact.

Things are looking bleak, even for Wall Street’s fearless girl.
Things are looking bleak, even for Wall Street’s fearless girl. Photographer: ANGELA WEISS/AFP/Getty Images

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Too Close for Comfort

Well this makes a change. For months, it has been necessary to explain that the stock market is driven by what money companies will make in the future, not the past, and so it can look through bad things that are happening in the present. But after a strange day Wednesday, which started with more fantastic news that the vaccines against Covid-19 appear to be both effective and safe, it’s now necessary to explain that when markets have already priced in good things for the future, they can be derailed by bad news in the present. This is particularly true if the misfortune is close to home.

So the mid-afternoon announcement that New York City’s public schools would be closing Thursday, in an attempt to thwart the resurgent coronavirus, caused stocks on Wall Street to drop with a thud:

News on New York City school closures hit the stock market

Other markets didn’t react as strongly. Ten-year Treasury yields, which had floated up to 0.89% earlier in the day in response to the vaccine safety news, fell back to 0.87%. The dollar rose slightly, suggesting an increase in risk aversion, but ended the afternoon no higher than it had been at midnight.

Why such a reaction in the stock market, then? High valuations, as now, render markets much more vulnerable to a sudden decline. Then there is the fact that the vaccine cannot help anyone already affected, or anyone infected in the next month or so, and that the latest Covid-19 wave has been growing steadily more menacing for weeks. This has generally played out to relative indifference; people are fed up with hearing about the pandemic, and the worst outbreaks in the U.S are in the high plains states, far from media attention. But the evidence grows stronger that the next few months are going to exact a heavy toll, in human and economic terms, across the developed world. Daily deaths have just overtaken their peak from the wave that swept through the Sun Belt in the summer, to reach a six-month high:

Daily Covid deaths have now overtaken their August peak in the U.S.

Deaths tends to be a “lagging” indicator. If we look at the number currently hospitalized, and therefore putting stress on a health system that is entering the cold months when its services will be most needed, we see a sharp increase to a level now well above the peaks from the previous two waves:

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Turning to infections, which are an inferior metric in many ways because they depend on how many people have been tested, we nevertheless see alarming evidence that this wave is broader and scarier than the preceding two. The following chart, produced by Longview Economics in London, compares each of the three waves from their base. The current wave is rising in a way quite unlike the other two:

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Not all of this is down to more testing. The proportion of tests that come back positive is steadily rising and is now back to a six-month high:

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So in the U.S., the outlook for the next few months is bleak. There has been genuine good news; treatment is improving and the chance of surviving coronavirus is far better than it used to be, while a good vaccine isn’t far away now. But one last horrible dose of the virus looks impossible to ignore. The New York schools closure, hitting close to home for many traders working in the world's largest financial center, and having a direct and nasty effect on living standards, was the catalyst for the stock market at last to take account of the dark winter ahead.

What of the economic effect? There still seems no reason to resort to the extreme shutdown of March. But the deepening impasse on Capitol Hill, with the White House no longer appearing to be trying to bang heads together on a deal to extend coronavirus benefits, begins to look very damaging. The benefits earlier in the year were so generous and promptly paid that few ever felt poorer. Now a “benefits cliff” is looming. The following is from Win Thin, foreign exchange strategist and economist at Brown Brothers Harriman & Co.:

A recent paper by two prominent labor specialists is sounding the alarm.  They calculate that around 12 million Americans will lose their emergency unemployment benefits by year-end.  This will be a huge hit to income and spending, to put it mildly.  By our calculations, it will be even more.  Our number includes 9.4 million currently on Pandemic Unemployment Assistance and another 4.1 million on Pandemic Emergency Unemployment Compensation, totaling 13.5 million that will see their emergency benefits end next month.  Of note, the government did not let extended unemployment benefits from the Great Financial Crisis expire until the end of 2013.  And that loss of benefits affected 1.3 million, only a tenth of what we are about to see next month.

This chart of continuing claims in the U.S., from Brown Brothers, shows the dimensions of the problem:

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Further, the bounce back in employment, while unquestionably impressive, has left the numbers signing on as jobless each week still far higher than at the beginning of the year. A significant proportion of these claim pandemic unemployment assistance. The prospect of a large swath of the population losing these benefits — just as winter encroaches, many were hoping to spend money on Thanksgiving and Christmas, and the pandemic returns with full ferocity — isn’t good:

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Beyond the benefits cliff, economic activity was obviously beginning to be affected by the virus once more. Wednesday brought news that New York’s transit authority was planning major cuts to employment and services, potentially making day-to-day life in the metropolis much harder. Data on subway users, however, show that activity has never recovered from the hit sustained in the spring. New Yorkers are still avoiding the subway if at all possible:

New York subway ridership remains far below normal levels

Meanwhile, activity in the great western European capitals of Rome, Paris and Berlin is collapsing again in November, after what had been a much more vigorous recovery, as Longview Economics illustrates using Citymapper data:

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Vaccine developments should mean the harm from the virus will be less than the worst fears, and that some sort of normality should return before the end of next year. There is still risk of great damage over the winter months, though. It took the news about New York schools, shockingly close to home, to get the stock market to confront this.


Having written about the dangers of political instability, it is worth making a quick trip to Peru. Nations don’t come much more politically unstable. Every single Peruvian president to leave office since 1985 has subsequently faced prosecution — with the exception of the two presidents who have left office so far this month. Neither of them has yet had time to be prosecuted.

In recent years, Peruvians had already witnessed one two-time president, Alan Garcia, opt to commit suicide rather than report to prison. The recent ructions follow a remarkable chain of events since the last election in 2016: Pedro Pablo Kuczynski, an Oxford-educated economist, was elected but stood down in 2018 over a corruption scandal. He was succeeded by Martin Vizcarra, his vice president, who was impeached by Congress for “moral incompetence” on Nov. 9 this year in an action widely denounced as a coup. Vizcarra was succeeded by the leader of Congress, and also leader of the opposition, Manuel Merino, who himself stood down this weekend after demonstrators against him were killed and a number of his cabinet resigned. His successor, Francisco Sagasti, a 76-year-old former World Bank official, was sworn in this week.  

The country has an appalling problem with Covid-19, and also, like other South American neighbors, faces a crisis over its pension and social security system. Political issues in the U.S. are tiny by comparison.

That raises a fascinating question; does political stability matter that much? Peruvian politics has been like a magical realist novel for decades, but it has still managed a remarkable growth and recovery. In the 1980s, much of the country was in the grip of a Maoist insurrection, and the country had to deal with hyperinflation. Lima is now a transformed modern capital city, and the country has grown far richer by feeding the appetite of China. Daniel Cancel argued earlier this year for Bloomberg News that while political instability had become business as usual, there has been agreement on economic stability:

The central bank exerted its independence, free-trade agreements were instituted and low levels of debt and stable fiscal accounts were established. As a result, the financial system today remains relatively immune to bouts of political uncertainty.

Even when a leftist has come to power, such as President Ollanta Humala from 2011 to 2016, budgetary policy remained mostly unchanged.

For comparison, think of post-war Italy’s succession of governments, which didn’t stop the economy from growing. Indeed, the Peruvian stock market has weathered the turmoil of the last few weeks. It gave up its gains from news of the first vaccine when Vizcarra was impeached, but has since surged back. When last seen, the S&P/BVL Lima 25 index was up more than 7% for the month:

Peruvian stocks have gained 7.6% under three presidents this month

However, if we look at the performance of copper, on which Peru’s economy is dependent, we can see that the political disarray has had an effect. A rising copper price usually means that Peru’s stocks outperform other emerging markets. Of the last few months, exactly the opposite has happened:

Peruvian stocks have lagged as the copper price recovered

If the country can make its way through to the next presidential elections, due early next year, without further mishap, and if China’s growth can keep the commodity complex growing, then Peru might offer an interesting bargain. But it would be great to see what its leadership could achieve for the country if they could cut out the political dramatics. 

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