Please note: this blog was published in April 2020 and its content is based on what was correct at the time of writing. As a result, some of the facts and opinions may no longer be current or relevant.
Coronavirus has dominated the news so far in 2020, causing significant impact on the markets. Our Head of Investment Strategy, David Semmens, shares his insights on the situation. We look at how this global pandemic has driven sharp economic change and outline what the future may hold.
What’s the economic impact of coronavirus?
We’ve just seen the longest global economic expansion come to an abrupt end, caused undeniably by coronavirus covid-19 (C-19) spreading rapidly around the world. The speed with which it transferred has caught both policy makers and financial markets off guard.
On the 20th December 2019 there were just 60 confirmed cases, all located in the Hubei Province, China. However, as of 16th April 2020 there are now more than 2 million confirmed cases world-wide.
To try and slow the spread of the disease, many countries introduced “stay-at-home” orders, which has seen over 50% of the world’s population being confined to their homes. Currently, there’s a large difference in testing rates across countries, but early signs show that a lockdown strategy does achieve its goal of slowing C-19’s spread. However, there have been very few countries not implementing this tactic, for us to see and understand the effects of other approaches.
The ‘stay-at-home’ orders are unusual, not just because it’s unprecedented, but as it is causing a man-made recession. By bringing in legislation that limits activity, we’ve seen both global economic activity and spending slowing rapidly. It has also triggered a large rise in unemployment, most notably in the USA, but affecting countries across the world.
What has the response been like?
It’s been good to see both central banks and government policy makers responding quicker than they did during the Global Financial Crisis. The policies they’ve introduced have been significant, slashing interest rates and increasing government spending more than at any point we’ve seen since World War Two. This swift and aggressive action has provided a much-needed cushion to the global economy, but it is unlikely to prevent what might become a global recession.
The impact of C-19 has made the current oil price spat between Saudi and Russia a much lower priority for the global economy. While it’s still important for oil producing countries, and has large geopolitical implications, a lower oil price generally acts as a tax cut for consumers. This means that they can save or spend additional money, not spent on petrol, in other places.
What could happen next?
The coming quarters, especially the one we are in, are likely to be difficult. Not only will the world have to come to terms with the terrible human loss caused by C-19, but we probably won’t see the full magnitude of the economic impact until things start to return to normal. We can already see that markets are expecting a decline in near-term earnings for companies, and government bond prices are at, or close to, record lows.
As long-term investors, we’re looking ahead to the recovery and what form it might take. It’s important to note that governments and policy makers learnt their lesson from the financial crisis and acted swiftly and decisively to provide support. In addition to this, they’ve also shown a willingness to increase this support if necessary. This support is key to underpinning the global economy in the months to come. Doing whatever it takes and dealing with the cost later is hard to argue with, but there will be a cost to pay later. It’s most likely that we’ll see a combination of higher taxes and more streamlined government services.
We’ve seen an immediate slowing of economic growth caused by both the supply and demand side. This is because factories, restaurants, estate agents, and shops are all closed for business, and consumers are told to stay at home, with any holidays and flights cancelled, causing most spending to be reduced. There’s a question about how quickly demand and supply return to normal, and that all depends on the success of reducing the number of C-19 cases.
Of course, there’s a potential ‘silver bullet’ in the form of the production and distribution of a vaccine. However, this isn’t as straightforward as discovering a vaccine. For context, one of the US Food & Drug Administration’s (FDA) faster approval methods (imaginatively called Fast Track), appears to offer a potential sixty day route to approval. But that is a sixty-day period after a vaccine is created and passes initial tests. In fact, a recent Harvard Business Review article puts the deployment timeframe closer to 18-24 months. While seeing success sooner would certainly lift global optimism and financial markets, a return to work is anticipated well before then, as we’ve seen already with selective activity resuming in China.
Are there reasons to feel optimistic?
Yes, plenty of them in fact. Around the world we've seen policy makers provide aggressive support, either in the form of additional government spending and/or tax reductions (fiscal policy). This is typically combined with lower interest rates or further quantitative easing (QE), where central banks purchase financial assets, such as government bonds, to lower interest rates and increase the money supply to support the economy. The support measures being offered are wide, varied, and being offered much quicker than they were during the financial crisis.
Some countries, like Malaysia, are providing one off payments to those in industries most affected, such as tourism. While others, such as Poland, have offered broader economic support by paying the salaries of the self-employed unable to work, with loans and grants being provided to support companies. Where possible, this is being provided under a ‘whatever-it-takes’ framework and has helped financial markets turn the corner. Add this to the slowdown in infection and death rates in some of the worst affected countries, and there’s lots to be optimistic about. The real test will be whether this reversal continues as lockdown measures are withdrawn.
It’s also been impressive to see how quickly the world has been able to adapt. Much of this adaptation has been digital, but innovation creates opportunities. With gatherings banned, offices closed, and air travel largely eliminated, video-conferencing and working from home/remotely has seen rapid adoption. This creates a genuinely interesting conundrum for employers who expect their employees to be in the office for their allocated hours. Similarly, universities, especially those more ancient, are having to overcome any aversion to online classes to allow students to complete their studies this year. As doctors surgeries close to all but the most urgent cases, telemedicine is also seeing rapid adoption. The benefits of this not only reduce the spread of the virus, but also removes the need to commute for a doctors appointment.
Do we still need to be cautious?
There’s no denying that, at present, the economic situation is difficult. Outside of those sectors that have suffered the most such as airlines, tourism and restaurants, are those dependent on the overall economy’s health, including banks, construction and the automotive sector. Even the US healthcare sector has not increased in value this year. You’ll find that there are precious few positive economic stories right now outside of companies helping office workers work remotely and online retailers. However, financial markets should serve as an indicator of economic expectations rather than providing a live status update. This is why, historically, stock markets typically turn well before the real economy bottoms.
However, it would be naive not to consider the risks to the outlook. Firstly, the sustained eradication of the virus is necessary for a return to “normal”. Next, policymakers have provided a significant amount of policy support, much of this will need to be withdrawn in the case of monetary policy and increased government spending paid for. The shocks to the real economy and the financial system are being delayed at this point by government intervention. But this cannot last indefinitely.
How does this compare to the Global Financial Crisis?
To put it simply, as much has already been written on this, the Global Financial Crisis arose primarily due to excessive lending to primarily US homeowners and some Eurozone governments. This led to the bursting of the US and then Global Housing Bubble and was followed by the Eurozone Debt Crisis. However, this did not occur over a single quarter in the year, as has been the case with C-19, moving from a remote Chinese province to having confirmed cases in over 180 countries.
In our opinion, the C-19 case can be considered a more discrete event and as such should allow for a much quicker recovery than we saw after the GFC. Rather than a credit event causing stress in the global financial system leading to the rapid slowdown of the economy, a global pandemic as declared by the WHO, has seen government’s introduce strict “Stay-at-Home” measures and created a man-made recession.
While, economics forecasters largely agree that the current economic decline will be sharper than the GFC, they do not agree on the strength of the recovery that follows. This very much depends on how quickly C-19 lockdowns are reversed and the rate of the return to normalcy. Early evidence from those countries affected earliest appears to suggest that lockdowns are working. As restrictions are lifted and people return to work activity will rise. It is this bounce back the world is looking forward to.
What have the team being doing in portfolios?
The large amount of uncertainty around the outlook reinforces our belief in the necessity of a globally diversified portfolio. This has not changed. We took the stock market sell off as an opportunity to increase our exposure to equities since we see bonds as being expensive and investors were being driven by short-term fear. We do not see a fundamental collapse in the economy, but a sharp shock that has knocked the economy drastically off course. We also took advantage of the steep decline in the pound to hedge our foreign exchange exposure, both reducing volatility and providing a boost to performance.
We’ll continue to monitor financial markets and global news as we focus on protecting your Plan and remain ready to act when opportunities arise. As always, we are committed to keeping you updated and will communicate with you regularly as the situation continues to unfold.
Please remember that past performance is not a reliable indicator of your future results.
With investing, your capital is at risk, so the value of your investments can go down as well as up, which means you could get back less than you initially invested.