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Capital Economics, a highly respected organisation supplying immediate and highly relevant economic analysis, has gathered some interesting data on the economic and the potential recession facing us. We investors need to make a judgement on likely future scenarios for various industrial sectors and so we must consider the macroeconomic environment impacting those sectors.
Whilst the Capital Economics team are very able, it must be noted that the level of unknowns on the persistence of the Covid-19 health crisis means we all have to accept a high level of uncertainty in any forward looking economic analysis. How long will severe lockdown last? When it is eased, will it only be by a small amount or will we go back to normal within days?
Nobody can answer these questions with certitude. But we can make reasoned assumptions given what we know. Capital Economics has assumed that severe lockdown will be in place across most of the world for April and there will be a gradual lifting of restrictions in May.
You and I might think that its optimistic to think that we can start to open-up society in May. Perhaps we won’t have the testing, taking and tracing regimes up to speed by then? Perhaps the government may want us to go back to normal, but families refuse to take the risk of going to work or the shops, airports and restaurants?
My judgement, for what its worth, is that Capital Economics are erring on the more optimistic side – there is a distinct possibility that most of the restrictions will remain in place as we go into 2021 and therefore the economic impact will be worse than what it shown below.
There is a list of Capital Economics publications from which I have taken these quotes at the end of the end of the Newsletter.
Virus waves
“Broadly speaking, there are two different ways in which viruses recur: through subsequent waves of a mutated virus or through multiple peaks of the same one.
The 1918 flu is thought to have come in three waves with each more severe than the last, although reporting and recording was patchy.
Flu pandemics in 1957 and 1968 had multiple waves. And more recently, the 2009 H1N1 “swine flu” started in April and was followed by a second wave in the autumn.
Pressure to ease containment measures before the virus is fully under control, most notably in the US, might cause an unintentional resurgence. And we have already seen a renewed pick-up in infections in North China, Singapore and Japan, at least partly due to re-infection from elsewhere in the world.
Hopefully, a vaccine will be found in time to prevent multiple peaks from occurring. But it is worth considering what the economic impact of any resurgence might be in the meantime.
There are several reasons to think that the effects might not be as severe as the current wave. For a start, there should be increasing immunity in the population which could limit the need for containment measures.”
“For some companies that are just about surviving now, a second wave might be the final straw that tips them into insolvency even if the related containment measures are less severe.”
“The behavioural implications of a second, or indeed multiple, peaks could be very different to those of a one-off pandemic. If the virus seems set to recur regularly, it is much more likely that people will permanently change their behaviour to avoid crowds. This would increase the risk of sustained economic damage, with industries like leisure and tourism particularly exposed.
The upshot is that there are reasons to think that any resurgence in cases in the months ahead will have less severe immediate economic effects than the first peak. Nonetheless, it would make any recovery much slower and increase the permanent loss of output likely to occur as a result of all this.”
What about the global economy?
Global GDP will fall at its steepest rate since WW2; a contraction of 5.5% this year. For comparison, in the 2008 financial crisis world GDP was down only 0.5%.
Even though Capital Economics says “once the virus is under control output should rebound” they also note that it will take years to get back on the path we were on pre-Covid-19.
“Policymakers’ bold action should prevent this recession from turning into a depression… And most countries’ banking sectors are healthy enough to stop this morphing into another financial crisis.”
“Once the “shutdowns” are eased, the global economy’s capacity to produce goods and services should rebound strongly. Firms will re-open and people who were temporarily laid off will go back to work. That said, restrictions may be eased in a gradual and piecemeal manner. On this front, there is a risk that some of the rebound that we expect in Q3 ends up coming later than that.”
“Moreover, we suspect that some demand weakness will linger. Consumer and business confidence might well remain subdued for some time, not least if fears of a second wave of the virus linger. In some countries, there might be the prospect of a new wave of austerity to repay the rise in public debt.
“When world GDP contracted by 0.5% in 2009, pre-tax earnings of global non-financial corporations plummeted by 45%. We’re expecting a 4.5% decline in world GDP this year, so there’s a good chance that earnings will fare worse than they did in 2009. Even if they fall by the same 45%, the overall interest cover ratio (pre-tax earnings coverage of interest expenses) should fall to a historic low.”
“Banks can hardly escape large loan losses in the worst global recession since WWII…Even where banks’ direct exposure to affected firms is small, they will face losses on loans to households that are struggling in a weak labour market”. Banks are also exposed to leveraged loans.
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