Uncertainty about the virus has fallen in a good way as we know more about the profile of its spread, as the growth of new cases and fatalities in Italy and Spain follow the same patterns as in China and South Korea. The US is at an earlier stage, although the daily rate of deaths has slowed in New York, the worst-hit state. The liberal democracies of Europe and the US still need more time to emulate the containment successes seen in Asia; if not, the authorities will face very difficult decisions about when to relax their respective lockdowns.
Uncertainty has also fallen regarding the economic damage from the pandemic, but not in a good way. Forecasters have finally realised just how horrendous the economic damage is going to be. Last week, I highlighted that over 4 million Americans filed for unemployment. A number totally without precedent – until the end of last week that is, when another 6 and a half million followed suit. Economic growth looks set to drop by at least 10% in both Europe and the US for the current quarter. Another record.
Central banks go large, but interest rates may not
Central banks around the world have flooded the markets with liquidity and unconventional measures have become the norm as governments have announced huge fiscal packages. Japan is the latest to join the list. Government deficits will exceed 10% of the respective economies in most countries; perhaps closer to 20% for the US. We expect the Euro-group to announce a big package this week. Many fear that, as a result of all this, interest rates will rise and global austerity programmes will need to be put in place once the world has recovered from the virus. I’m not so sure. It is true that government debt will be much higher and interest rates may be a bit higher, but the forces that kept rates low before the pandemic will still be there, if anything, stronger.
Economic recovery is still an unknown
Fiscal and monetary policy can soften the blow of this massive recession but only an end to the lockdown will produce economic recovery. The evidence from China is promising, production has recovered to 80-90% of previous levels. Consumers have been slower to recover, partly because they have had to draw down their savings, but they are coming back. For the rest of the world, it all depends on stopping the spread of the virus, not merely containing it. Some experts, including the ones advising the UK government, expect the lockdown to be eased and tightened in phases over a period of up to a year. If that’s the case, recovery will be relatively slow compared to the sudden stop caused by the imposition of the lockdown. The honest answer is that we just don’t know. But even on pessimistic assessments, we should see a vigorous economic recovery over the latter part of this year and into 2021.
What does this all mean for markets?
Dividends are being slashed, earnings are collapsing, defaults will rise. But markets are forward looking, and if they feel confident that this will prove to be temporary – and I think they will – they will trend higher. The S&P 500 has been in a relatively narrower trading range since the US passed their bumper fiscal package. Markets may well require signs that the lockdowns in Europe are set to be eased, and there will be setbacks, but I still think we’re headed higher.