Summer risks for stock markets

Stock markets are flying high as we head into the summer months, but with the global economy still suffering from the coronavirus and the measures taken to combat it, it is perhaps time to look at the potential risks for a ‘summer swoon’.

Bad economic data

Data from the end of Q1 was bad enough, but things are likely to stay bad throughout the second quarter. The contraction in GDP for the first quarter in major economies is merely a prelude to a much sharper drop for Q2. The question is, if markets were able to weather the storm in Q1, can they repeat the trick in Q2? And if things are much worse, will stock markets be vulnerable to more falls now they have rallied sharply from the March lows?

An increase in bankruptcies

The initial shocks of lockdown did not cause many companies to shut down entirely. Government support for workers and emergency loans will help tide firms over. But if these are cut back or withdrawn, then some companies, particularly in key consumer sectors like restaurants, travel and retail, will go to the wall. This could see borrowing costs spike as banks rein in their lending programmes, causing other normally-successful businesses to head towards bankruptcy as well.

Social distancing remains in place as lockdowns end

Lockdowns were successful across much of the developed world because governments were sufficiently clear about the risks if the disease spread. But people will not easily forget the warnings even as they are allowed to return to a form of normality. Markets have arguably already priced in a V-shaped recovery, hoping that the world returns to normal in rapid fashion. But if consumers stay at home and spending remains muted then it will be hard for the economy to bounce back.

A second wave of infections

Infection rates are falling in many countries, but the easing of lockdowns may bring a rise in infections that could cause markets to retreat again. While countries now know how to cope with an outbreak, renewed lockdowns will bring an economic cost on top of the existing problem.

Central banks ease off stimulus efforts

While stimulus efforts will not go into reverse, the flood of liquidity that supported markets in Q1 may halt for the time being. This will remove one key driver of stock market gains, perhaps leading to a near-term pullback or a deeper drawdown.

Corporate earnings get worse

Most companies suffered a hit to their earnings in Q1, but as with economic data Q2 is likely to be worse. Q2 will reflect the full impact of lockdowns, as opposed to Q1 when only March (and then not all of it) was affected by lockdowns. The question is the same as it is for economic data – is a big drop in earnings already factored in, or are markets at risk of another sharp drop as the reality of company earnings becomes clear?

The above are not sure-fire outcomes for the months ahead, but they do represent points to be concerned about. Many of these are already known about, and are not arriving out of the blue like the coronavirus itself. And if there is a summer selloff, it may be caused by something else entirely. But investors would do well not to ignore the above entirely.