24 June 2020
What is the safest way to re-open the world’s largest economies amidst the Coronavirus pandemic?
With Europe, the United States and the Asia Pacific region accounting for tens of trillions of US Dollars of GDP, the task seems daunting - particularly when testing and tracing is still limited and a vaccine probably months away. The news of a resurgence in cases in South Korea, Germany and China further complicates matters. Subsequently, the economic costs have also been, and will continue to be, substantial. Finding a balance between “life and livelihood” is seemingly a Herculean task.
Despite sobering economic data and a lack of forward guidance from corporations, stocks have generally continued their march higher. There are two main story lines, and the market is certainly looking at the optimistic one. Unprecedented monetary and fiscal stimulus, improved market liquidity, virus levels stabilizing and efforts to reopen global economies create reasons for optimism. At the moment, equity markets seem to be largely ignoring the more negative picture of record job losses, soaring unemployment, pending bankruptcies and an unclear trajectory for a full re-opening of the economies.
Whilst the speed of the fall and recovery has been the main talking point, investors are now debating the alphabet in terms of the likely shape of the economic recovery.
It is important to bear in mind the difference between markets and the economy (one expression of which is via GDP) when talking about an “economic recovery”. Markets tend to be forward looking and will react to anticipated economic conditions, good or bad.
This forward-looking characteristic of markets will further be influenced by the expected results from policy decisions both fiscal and monetary, positive or negative. Various economic recovery scenarios using GDP (Gross Domestic Product) when plotted on a graph will look like:
- The letter “V”, best case scenario, assumes a swift rebound in economic conditions, and historically, most recoveries have been V-shaped, with activity returning to prerecession levels in the same or less time as the duration of the downturn.
- The letter “U” scenario, signalling a slower, drawn out recovery, of which the clearest example was the Global Financial Crisis (GFC). Over the course of 2008 and 2009, the contraction in real GDP became gradually more pronounced, and the subsequent rebound to pre-GFC levels in many countries took years.
- The letter “W” (double-dip recession), reflects another fall after a non-sustainable recovery.
- More worrying still, an ‘L’ shaped response would mean stagnant economic growth, and a drawn out, slow recovery.
How can share markets rise higher as the economy destroys millions of jobs worldwide and we enter deep recession?
To summarise, currently the share market is looking through the “macro noise” and assuming a “V-shaped” economic recovery with broadly:
- Global economic activity having now bottomed, and with an expectation of a strong recovery in advanced economies in 2H 2020.
- Assuming infection rates don’t reaccelerate as economies begin to reopen, which would prompt the reimposition of control measures.
- Share markets are assuming that the fiscal and monetary stimulus deployed (and future promises of more if required) by governments worldwide will allow economies to push through what is hoped to be a short “V-shaped” recession and avoid a retest of the bottoms encountered in March.
- Share markets are assuming a low growth, low interest rate environment and therefore placing a higher value on equities relative to other asset classes. In other words, if you cannot get a return from cash or bonds you need to be in equities.
The important point for investors to note is that based on earnings growth assumptions under a “V” shaped recovery, the market looks good value, while under a “U” it looks fair value, under a “W” overpriced and a “L” extremely expensive.
As such, we continue to monitor all data sources daily and act in a cautious manner in terms of portfolio positions.
Findex Advice Services NZ Limited trading as Findex
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