Edi's View on COVID Stimulus, R-Rate and Recoveries

Overview

Edi is one of our analysts on the team and shared his thoughts on global market recovery, the impacts of our current pandemic and the proper stimulus measures to take.

Edi's Thoughts

So we’re in a bit of an economic downturn. But what can we expect from this global recession? I mean, we are in a global pandemic… This is something we have never seen.

Let’s put our thinking hats on and focus on what the next steps could be for the economy.

If you read any article about recessions lately they talk about the magical V shaped recovery, you’ll know the V-shape is the one we’re hopeful for since that gives us the quickest route to recovery.

V-Shaped Recovery

In the V-shape scenario we see a decline in the economy followed by a relatively quick and strong recovery as the economy instantly bounces back. Theoretically, this type of recovery is ideal because it means there is less likely to be lasting damage to the economy. Economic growth quickly returns to the baseline.

This bounce-back in the economy resembles a V-shape on the chart. And, yes, one thing you’ll soon figure out is that economists aren’t the most creative when it comes to naming things.
Unfortunately, a V-Shape recovery is not guaranteed. There are alternatives which mean a slower, less desirable rate of recovery.

There may be situations where we have a V-Shaped recovery at first before the economy then falls back into a recession. This would then be a W-Shaped recovery.

What will happen?

But is that likely to happen?
First of all there needs to be a slowdown in the spread of the virus.

An important metric is the ‘R’ rate which needs to be below 1. This is the reproduction rate of the virus; so it shows us how many people an infected person will pass the virus onto, on average.
Since most countries are now coming out of lock-down and easing restrictions, we can clearly see that this has been reducing, but unfortunately, some countries aren’t that far below 1.
In fact, Germany’s R rate spiked above, suggesting they may soon be coming out of lock-down as well. With large social gatherings taking place around the world, it could be the case elsewhere too.
Next, we would be looking at data suggesting the economy is picking up speed again.

In the US, the latest employment figures in June were well above expectations and a very good sign that the economy is getting back on track; businesses are reopening and rehiring.
However, there was a misclassification error in the data release and the actual numbers were not as good as they seemed on the surface.

Many analysts expect to see a more gradual reduction in unemployment instead and this would be more of a characteristic of a U-shaped recovery. This is also in line with what GDP is likely to show us about the growth in the economy.

The Federal Reserve shot down the prospect of a V-Shaped recovery in their latest economic forecast after suggesting that GDP would contract by 6.5% in 2020 and take two years to reverse.
They’re looking at more of a U-shape or a tick.
In fact, according to the Bank of America, global fund managers aren’t so optimistic about a V-shaped recovery either, with just one in ten expecting one.

You see, the problem might not be as simple as demand picking up in the economy again as lockdown ends. 
A paper also showed that the recovery would be slow and incomplete due to negative supply shocks. The demand component of GDP is likely to recover quite quickly over several quarters, but negative supply shocks, which are associated with lower productivity growth, higher unemployment and other reductions in production capacity, may remain for years.
This means that unless supply shocks can be reversed very quickly, it’s going to take some time to recover. In fact, certain areas of the economy, such as tourism and entertainment may even need to reinvent their business models entirely to get back on track in a socially-distanced world. This would massively impact countries where tourism contributes to a big chunk of GDP.

So all of this points to a slower recovery than a V-shape, but a still fairly steady return to normality.

But then there’s the big question on everyone’s lips… What if the R-rate increases?

In the June OECD economic outlook, they outlined two core scenarios that they say are equally likely; what they’re referring to as the ‘single hit’ or ‘double hit’. If you’re clued up on your recession shapes, you’ll recognise these as the v-shaped and w-shaped recoveries. And if you didn’t know that, time to watch our video on recession shapes.
The ‘double hit’ refers to what would happen if there’s a second wave of the virus.
Equity markets are still showing resilience, backed by stronger than expected economic data and ongoing intervention by the major central banks. Cases of coronavirus still continue to explode. Once again in the USA and many countries are having to reverse back into lockdown. For now most funds are remaining cautiously optimistic and we are being selective about cyclical equities.  
The global economy is back in expansion mode with continued positive data from Asia, improving retail sales in Germany and another big USA jobs number.
A worrying deterioration in Covid 19 data warrants caution; governments need to get the virus under control again or risk their progress to date.
Since there is no vaccine, a second wave of the virus is still a very real threat right now, and already in many places, including the US, they are beginning to see an uptick in COVID cases. This is a similar scenario that has played out in previous pandemics, as complacency and fatigue with countering a virus begins to set in.

If GDP does increase, but the economy is slammed back into lockdown that could cause a double-dip as GDP growth once again declines into negative territory.

But let’s look on the bright side and remain hopeful.
One of the biggest factors has been and will be economic stimulus. Just like we saw in the financial crisis over a decade ago, a slow and inadequate response can drag the recession out longer than needed.

This time, major central banks and governments were quick to act and provided record amounts of stimulus. However, the effect from this will begin to fade, which may mean more monetary and fiscal support will be needed to keep the recovery chugging along.

It seems likely that that’s what’s going to happen. The US government recently announced they are considering a further $1 trillion in infrastructure spending and the Fed are revealing plans to begin buying individual corporate bonds. The US stimulus is also trickling into emerging markets as a by-product as well.

Conclusion

So, in other words, as long as the virus disappears and the central banks and governments continue to act fast and adapt to the changing market conditions with adequate stimulus, things will be just fine in the long run.

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Disclaimer:

Please note that this email is my personal opinion only. I am not a licensed financial advisor, and any information shared or discussed is not to be construed as investment advice. Trading and investing involves a degree of risk, and is not suitable to all investors. Please consult with your financial advisor before making any sort of investment decisions.