COVID-19 – Worse than the Great Financial Crisis?

19 March 2020

4 minute read

We discuss the gathering economic and societal impact of COVID-19. What can policy makers do? Is the bottom of the bear market near?

Who's it for? All investors

What you’ll learn:

  • A plausible best and worst case scenario for the next 12 months as the attempts to contain COVID-19 hit the global economy
  • What policy makers are doing about it and whether they can do more
  • Whether markets have gone too far, making this a good opportunity to buy, not sell.

The last stand?

Markets remain skittish to say the least. Investors continue to grapple with what the worst case outcome really looks like as the world economy powers down. What are the main stress points? What can we expect from policy makers in the coming weeks and will it be enough? Is it time to sell everything and take succour in the safety of simple cash?

The future

As always the danger here is that we exaggerate our ability to see what comes next. Nobody can. At times like these the hard numbers of economic forecasting are even less use than usual to an investor. The reality is that there are myriad paths ahead, some more likely than others admittedly. However, for all of us, it is probably more helpful to think about this full range and how incoming information changes that distribution of potential viable outcomes. It is worth noting that the below are the extremes of potential scenarios and not a prediction of the reality that the market will face.

A guess at the best…

In the best case scenarios, we can hope for a benign mutation of the virus, or indeed a successful test of Remdesivir or one of the other potential antiviral treatment candidates (news is due here imminently). Further help might come from the virus exhibiting the same degree of seasonality we have become used to in its coronavirus siblings. As a combination of treatment and seasonality combine to reduce both the case fatality and transmission of COVID-19, we see the economy bouncing back strongly in the second half of the year. The extra fuel being loaded on the global economy by policy makers supercharges that rebound, with economically sensitive assets, such as shares and credit (corporate debt), soaring as a result.

And the worst…

The gloomier scenarios are characterised by persistent flare-ups in the coronavirus as soon as quarantines are relaxed. As an aside, we are not so far seeing evidence of this in China’s tentative return to work, but there is time. Nonetheless in this scenario, where strict social distancing remains in place for longer than currently planned, you could plausibly imagine widespread societal and political dysfunction, bankruptcies, even a depression. A shorter leap of imagination is required for worries about the large quantity of US corporate debt perched somewhat precariously on the ratings line separating junk credit (non-investment grade) from investment grade to become a problem. The plunge in oil prices has understandably given such fears a little more impetus.

What about the policy response?

We are already seeing a significant step in fiscal (the use of government revenue collection – taxes or tax cuts – and expenditure – spending – to influence a country's economy) and monetary (control of the supply of money and interest rates in an economy) policy in the last few days in particular. So far these measures, both enacted and planned, already exceed that approved during the crisis of 2007-09. We expect more in the coming days and months as the reality of the situation starts to be described by incoming economic data. Many governments are also stepping up to guarantee large chunks of credit for banks, deferring tax intra year and redirecting already appropriated budget funds. The fiscal package currently making its way through congress is potentially worth over 5% of GDP (gross domestic product – a measure of the market value of all the final goods and services produced in a specific time period).

When will markets settle down?

The most plausible paths ahead for us sit somewhere in between the extremes sketched out in our scenario analysis above. A degree of seasonality in COVID-19 is not proven, but neither is it unreasonable to assume. Treatments are likely forthcoming too, even if we are going to have to likely wait a lot longer for a vaccine. Policymakers are already acting forcefully and more will come in our expectation. Very low government borrowing costs are likely helping overcome previous qualms about sovereign (government) debt loads. However, there are vulnerabilities in certain parts of the world, some of which may only become obvious after they have hit and a degree of humility is of course always appropriate.

Nonetheless markets seem to be overweighting the potential for the worst case outcomes in their scenario analysis. This suggestion is corroborated by the extreme lows in measured investor sentiment. On some estimations, this is already way below levels that investors plumbed in the last recession. A more balanced assessment of the likely paths ahead, would see shares and core government bond yields (the return on a bond) quite a bit higher from here. We are gently positioned for this re-assessment in our multi-asset class funds and portfolios at the moment.

For those looking for a little longer term perspective, we can point out that net of all recessions and downturns, the US economy is nine times bigger in real terms than in 1950 and its stock market total return is over 145 times as high. We will never be able to reliably avoid these slumps and recessions unfortunately. The more we try and protect against them, the more we tend to restrain the more routine force that drives the returns from a diversified fund or portfolio over the long term – humankinds' innate restlessness, creativity and capacity for innovation.

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