The cure must not be worse than the disease
While new coronavirus cases are plateauing, although not yet declining significantly, countries in Europe are beginning to judge the economic pain wreaked by Covid-19 containment measures to be worse than the infection itself and are shifting focus slowly but surely towards revitalising their economies.
A lifting of lockdowns - however gradual they may be - will result in a rise in economic activity from a very low base, so quarter-on-quarter GDP growth is likely to be positive in Q3.
Downside protection amid 'gloomy economists' and irrational markets
Yet, with social distancing set to persist, activity will be slow to recover and there is still risk that Q3 could negatively surprise markets, triggering a change in sentiment.
Lockdowns also may need to be reintroduced if and when hospitals look like they will be overwhelmed again, and markets have yet to price in this key risk.
On the upside, however, government action may be quicker the second time around, hopefully preventing a more severe market reaction.
While the European Central Bank (ECB) was initially quick to provide support, markets in Europe have once again been left disappointed by the its failure to adequately boost asset purchases.
Essentially, its chosen strategy seems to be sweetening banks in order to convince them to lend into the real economy.
ECB President Christine Lagarde's frightening estimates of the likely euro area economic decline perhaps suggest the central bank should be acting more aggressively at this stage.
Further, recent challenges around the prospects for debt mutualisation emphasise a lack of solidarity across the eurozone.
Overall, these measures are all moving in the right direction, so market disappointment is unlikely to be drastic.
However, despite the ECB's efforts, investors may still be waiting for Lagarde's "whatever it takes" moment.
Industry fears market turbulence will lead to surge in 'fallen angels'
Central Bank support will continue to drive assets higher, but against this weak economic backdrop, vulnerabilities will continue to grow.
In the meantime, investors can take comfort in the fact that the worst of the pandemic is likely behind us, the market bottoming process is underway, and with markets typically leading the economy, we are - plausibly - clear of the market lows.
Seema Shah is chief strategist at Principal Global Investors
Bull points
• Europe has passed the peak of market uncertainty and is starting to look towards measures to ease national lockdowns
• While the economic devastation from Covid-19 has been unprecedented, so have been policymakers' responses and the market bottoming process is now underway
• If there is a subsequent lockdown, government action may be quicker the second time around, preventing a more severe market reaction
Bear points
• Markets risk being overly optimistic about the economic recovery and second half of 2020 GDP in Europe could surprise on the downside
• Markets have yet to price in the possibility of a second wave of the virus and a subsequent lockdown being introduced
• Recent challenges around prospects for debt mutualisation emphasise a lack of solidarity across the eurozone
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