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The Charging Bull is adorned with a facemask in New York on May 19, 2020. A troubling 47-per-cent rise in new COVID-19 cases in the United States over the past 14 day is key to the downward shift in investor sentiment.

TIMOTHY A. CLARY/AFP/Getty Images

If the stock market’s robust rebound that began in March was largely owing to encouraging signs that developed economies were successfully slowing the pace of novel coronavirus infections, surging infection rates in many U.S. states are now causing an urgent reality check.

The S&P 500 has retreated nearly 5 per cent from its recent high on June 8, even after Thursday’s 1.1 per cent gain. Canada’s S&P/TSX Composite Index has fallen more than 3 per cent over the same period, hitting pause on what had been a sharp rally.

Several factors are contributing to the downturn, including renewed trade friction between China and the United States, high stock valuations, depressed earnings expectations and concerns about the slow pace of the economic rebound.

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But the troubling 47-per-cent rise in new COVID-19 cases in the United States over the past 14 days, driven by surges in California, Florida, Texas and Arizona, is key to the downward shift in investor sentiment and was widely blamed for sending the S&P 500 tumbling nearly 81 points or 2.6 per cent on Wednesday.

“It would seem as though the acceleration in virus cases in more than 30 U.S. states may have caught some unsuspecting bulls by surprise,” David Rosenberg, chief economist and strategist at Rosenberg Research, said in a note.

He added: “The fact that the medical infrastructure can now handle the situation is great news and means a national lockdown won’t happen again. But as we are seeing in Texas, the reopening phase will be filled with bumps. The recovery will not be a V,” he said, referring to the shape of a strong rebound.

Mr. Rosenberg recommends investors focus on companies geared to producing what people need, rather than what they want – a utility-like category that includes cars, given that many commuters will likely avoid mass transit.

Kevin McCreadie, chief executive officer at AGF Management Ltd., pointed out that the risk of a second wave of infections is weighing against relatively upbeat developments such as improving U.S. retail sales and fresh government stimulus measures.

“So, it makes sense that investors are back on high alert as they weigh the strength of the economic restart to date against the potential impact further outbreaks could have on the economy,” Mr. McCreadie said in a recent note. As a result, he expects that the stock market will turn far more volatile over the next few weeks and recommends maintaining some downside protection, such as cash.

Still, the major indexes remain far above their March lows despite bad news on the virus front and the depressed global economy.

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Some observers ponder why stocks haven’t turned more turbulent already. John Higgins, chief markets economist at Capital Economics, suggested that there are three reasons why U.S. stocks haven’t fallen more severely over the past several weeks.

First, most policies such as low interest rates and government stimulus programs that were put in place at the height of the pandemic to support the economy and backstop markets remain in place. Second, although COVID-19 cases are rising, new deaths have not soared. And third, U.S. authorities for the most part have not yet returned to severe restrictions to hamper economic activity (although Texas halted additional reopening plans on Thursday).

“We therefore think that the biggest risk to the stock market from a resurgence in new cases is some combination of self-imposed withdrawal from economic activity by a nervous public and imposed withdrawal courtesy of new restrictions,” Mr. Higgins said in a note.

“This cannot be ruled out if new cases continue to rise sharply. But many people will not want to take a step back. And politicians do not want to see the economy suffer again,” Mr. Higgins said, adding that he expects the recent pullback in the S&P 500 will be short-lived.

Still, economists note that even the current level of business activity is hardly encouraging, which is why markets may be sensitive to rising levels of infection.

Ksenia Bushmeneva, an economist at Toronto-Dominion Bank, pointed out that the latest business barometer from the Canadian Federation of Independent Business for June showed that businesses that have reopened are operating at a mere 58 per cent of capacity, up just nine percentage points from May, which is weighing on profitability.

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“Everyone is adapting and realizing that this is a situation that will be here for a relatively prolonged period of time,” Ms. Bushmeneva said in an interview. “That will weigh on business and consumer confidence because there is added uncertainty over whether restrictions will be reinstated and to what extent.”

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