What’s giving markets the jitters and will it last?

After a strong run of late, local and global markets have developed a clear case of the jitters. There are a few things rattling them, with the risk of a second wave of COVID-19 at the top of the list.

The ASX has had a strong recovery in recent weeks – rising 35% from its March 23 low to its recent high. Similarly, in the US, which of course leads global markets, the market rallied 44% from its March low to its recent high.

The strong run up suggested markets were due a pullback, which is coming to fruition . For example, in Australia, we started the week 2.2% down, after an overall drop of 2.5% last week.

The real concern for markets right now is whether economies can continue to re-open and function normally. Markets in Australia, for example, have reacted well to signs of the virus being controlled, because it means businesses and local economies can re-open, and pent-up demand for goods and services can be met.

With that in mind, a second wave is the highest factor on my list of risks. For example, we have seen spikes in some US states, albeit the trend is still down in New York and other Northeast states, and some new cases in China.

In saying that, while a second wave is a significant risk, my base case is it’s likely not going to be as out of hand as cases in the first wave. We can use Iran as a guide here. Iran has experienced a true second wave, but the number of deaths so far has been lower than the first. It’s fair to assume that the experience of medical authorities and the preparedness of hospitals, doctors, people and the government play into this.

The other risks to consider on the road to recovery include collateral damage getting out of hand – for example, unemployment and bankruptcies spurred from the shutdowns. Another is global trade tensions between China and the US, which have been having an impact on markets for a couple of years now.

Broader issues which are flooding our screens are looking like background noise for markets right now, however significant they may be socially. For example, there’s a lot of talk about the impact of slowed Chinese tourism and Chinese students in Australia. These tourists and students are important in terms of the ongoing growth of the Australian economy, but at the moment, markets are seeing this issue as largely academic. Tourists and students are an important consideration for when the economy recovers, but right now nothing has been quite as severe economically as having most of the nation locked in their homes. As I noted last week, while social tensions spurred by the police killing of George Floyd are significant, they are so far not economically disruptive enough to have a major impact on markets.

Ultimately, as markets work through these risks, we may be in for a rougher patch in the next month or so. However, I ultimately see this pullback as a correction in a still rising trend, although the risk of a serious second wave will be the key thing to watch.