Macro views

Macro Update - 22 June 2020

Virus update: Lockdown in Beijing but British pubs to reopen
June 2020

As the virus declines in most of Europe but increases in parts of the US, and China puts Beijing back into lockdown, we look at the economic and market implications. And here in the UK, where national debt tops 100% of GDP, we look for some good news as pubs look set to reopen…

Let’s begin with the second wave in Beijing. The authorities have re-imposed travel restrictions, hard social distancing and closed all schools. That’s the bad news. The good news is that the number of cases in the last 4 days is only 190 – a tiny number – and that testing has been doubled to 92,000 a day in the city. With a focused and successful test, track, trace and isolate programme, the outbreak looks to be under control and factories and companies have remained open. We can see the impact in terms of reduced traffic congestion in Beijing and there will be an overall economic impact, but we expect that to be small and temporary.


China recovery a useful blueprint

Let’s take a look at China’s overall economy. As I’ve said previously, China provides a rough template for how our economies in Europe and the US might recover as the lockdowns are eased. After all, they are a couple of months further down the road.

Many forecasters are talking about a ‘tick-shaped’ recovery from the virus. Economies bounce but only briefly and fail to recover their pre-virus levels of activity.  But China’s data tells a different story. Some sectors quickly overshot their pre-virus levels and are now slowly declining back to a more normal trend. These include cement production, sales of autos, heavy trucks and smart phones. Pent up demand explains the overshoot. Once that is satisfied, things calm down to normal. By contrast, many services that have been hit disproportionately hard are now gradually improving but remain below pre-virus levels. These are services such as domestic flights, subway use and hotel occupancy, and they look set to provide a continuing boost to growth. More worrying are signs that new orders are dipping – much of that is no doubt due to weak demand from abroad. Of course, there are many differences between China and other economies, but I do expect a similar pattern with some areas overshooting, others recovering gradually.


Pre-virus profitability next year, provided second waves are small

Overall, I’m sticking to my forecast that we recover to pre-virus levels of economic activity, as well as corporate profitability, by the end of next year.

That forecast will only come to fruition provided that second waves are small, localised and temporary. Germany has disappointing news that the 7-day average of new cases has topped 500 for the first time in 5 weeks, and the respected Robert Koch Institute estimated over the weekend that the R0 number – the effective virus reproduction rate – had jumped to 1.79, from 1.06 on Friday and below 1 earlier in the month. The source is dominated by a single meat factory – and that puts it into context. I believe they could have this under control in a few weeks.

The US is also showing worrying signs of increased new cases, not just in the five smaller southern states, but also in the bigger states of Florida and California. Although new cases may be rising, fatalities are not, so we may have more positive news in coming weeks.

Economic surprises are a good indicator of market fortunes, as it is these that tend to move markets, rather than the absolute levels. Analysis shows that as the world collapsed into recession during the pandemic, negative economic surprises hit a record more than twice as many as during the Global Financial Crisis (GFC). The outliers in the recovery have been even bigger, with more than 10 times as many positive surprises compared to the peak as we recovered from the GFC.


Debts building but governments can roll it over

But what about all that government debt? Won’t that mean we get weaker a recovery, higher interest rates and inflation? Many analysts think we will, but I disagree. UK government debt topping 100% of GDP sounds shocking, as do the figures released last week showing that we borrowed well over £100 billion in May and June alone. But governments can roll these debts over, which lessens the threat of inflation. The private sector, on the other hand, will have to restrain their spending into the recovery, but government policy will remain supportive.


Gloomy forecasts give prospect of positive surprises

As for financial markets, they have been ahead of economic forecasts, diving faster into the recession as well as bouncing further. They’ve come a long way from levels that didn’t look very cheap even before the virus struck. But the background does appear to be positive and I am encouraged that so many are so gloomy about our prospects for recovery – that provides opportunity for positive surprises.

There is also evidence that investors, especially retail, have money to invest. So, I’m more positive about risk assets as I see the world beating this dreadful virus. There is still a long way to go, but perhaps investors will be able to allocate some of their spare capital to beer in the not so distant future…

Steven Bell

Managing Director, Portfolio Manager & Chief Economist, Multi Asset Solutions


Risk Disclaimer

The value of investments and any income derived from them can go down as well as up and investors may not get back the original amount invested.

The information, opinions, estimates or forecasts contained in this document were obtained from sources reasonably believed to be reliable and are subject to change at any time.

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