THE CURRENT PICTURE
China’s economy contracted by 6.8% in the first quarter according to government statistics, and an even larger GDP decline in the US and major European economies is expected during the second quarter. This is not an abstract, intangible cost, and ultimately it will hit households. Modelling indicates that in most European countries, a 10% drop in GDP over the year is likely to be associated with a rise of around two percentage points in the unemployment rate, with some variation according to the generosity of wage-subsidy schemes. In the US, where employment terms are generally more flexible, the unemployment rate might reach 20%.
At the moment public health must be the priority, and the economic impact could be much more severe if measures are lifted too early and Coronavirus spreads further. As investors, it is important to try to understand when it might be possible to re-open economies safely; the depth and breadth of the downturn can then be quantified.
Recent developments in Hubei province, the origin of the outbreak, may help in this endeavour. The region is now returning to some level of normality, with limits on travel to and from Hubei having been relaxed and residents returning to work.
At present, this is the only guide we have for assessing the likely duration and success of lockdowns in containing COVID 19. Hubei imposed a lockdown for 63 days (except for the city of Wuhan, where it was a little longer). So could Europe be unlocked within a similar timeframe?
LOOKING TO THE FUTURE
The virus’s dynamics can be measured by the daily change in deaths. This is a lagging indicator, but is less prone to misreporting than others such as official tallies of infections which ignore the untested.
This metric tells us that European countries are following the same virus path as Wuhan after lockdowns were put in place. In fact, new deaths in Italy and Spain peaked four and seven days earlier into the lockdown than in Wuhan. There are tentative signs that COVID-19 deaths in the UK may peak even earlier.
If European countries are able to maintain a similar trajectory to Wuhan, their lockdowns could also end after 63 days. That would be around mid to late May.
The US appears to be on a worse course than Hubei; it now requires a much faster ‘flattening of the curve’ to catch up with Hubei and Europe. The challenge in modelling the situation in the US is that lockdowns have varied state by state in both their start date and their severity.
Nonetheless the IMF have modelled the likely impact the expected lockdowns (based on the Chinese experience) will have on global growth:
ANNUAL PERCENT CHANGE IN GDP
|
Country |
2019 |
2020 |
|
US |
2.3% |
-5.9% |
|
Germany |
0.6% |
-7.0% |
|
France |
1.3% |
-7.2% |
|
Italy |
0.3% |
-9.1% |
|
Spain |
2.0% |
-8.0% |
|
Japan |
0.7% |
-5.2% |
|
UK |
1.4% |
-6.5% |
|
China |
6.1% |
1.2% |
|
India |
4.2% |
1.9% |
|
Russia |
1.3% |
-5.5% |
|
South Africa |
0.2% |
-5.8% |
Source: World Economic Outlook projections IMF
All of this amounts to a fall in global GDP of 3% in 2020.
The World Economic Outlook (WEO) modelled several other alternative scenarios: a 2020 lockdown lasting 50% longer than it is forecasting; a mild recurrence of the virus in 2021; and a protracted pandemic and longer containment effort in 2020, as well as a recurrence in 2021. In the worst case, the global economy would shrink by around 11% rather than 3%.
Although this appears grim, the good news – as far as investors are concerned – is the unprecedented global monetary and fiscal stimulus (in the US a 50% bigger stimulus than that seen in 2008/09) already announced.
Furthermore, much of the bad news is already priced into stocks including a 35% drop in dividend payments and a 30% decline in earnings per share. Current earnings forecasts based on IMF predictions are for a 21.7% decline in second quarter earnings and a full year decline of 9%*. If the IMF base forecast is correct, then the market looks attractively priced.
TAKING ACTION
When deciding how to act – given current market valuations – the forecast return is key. But these forecasts depend largely on two factors; firstly government stimulus but secondly, and far more importantly, when the lockdown ends and whether it is restarted. Quantifying the effect of both of these will be of huge importance and will better allow us to advise on what actions should be taken with client portfolios.
Two further points are useful to consider when it comes to investment decisions:
- Bear markets often unfold slowly because investors are unsure whether a recession is approaching. There is no such uncertainty about a recession now so it is possible that the selling that is normally over a protracted period is already in the price.
- Wall Street is expecting a sequel to the $2 trillion appropriation bill already announced in late March. The absence of one (although we expect an agreement on this by the President and congress soon) could impact stock prices in the short term.
Whilst the situation is finely balanced, we will continue to monitor the dynamics of the virus day by day. Determining when some semblance of economic normality will return to Europe and the US will be an important factor in deciding when corporate earnings and sentiment to risk assets could improve.
Although it is difficult to determine how things will pan out in the very short term (within the next three months or so) we can be more confident over the medium term, three years from now. By then the world will have returned to a semblance of normality with the stock market reflecting the globe’s recovery in both physical and economic health.
Given this, the best course of action is for investors to be disciplined, and approach any investing in a normal systematic way, no matter how nerve-racking it might currently feel.
To discuss any aspect of your investment portfolio please contact your nearest office.
Julian Broom, Chief Investment Officer
julian.broom@thefrygroup.co.uk
*Factset Research 17/04/20 – S&P 500