Keep calm and carry on

An unexpected global pandemic has triggered the third bear market of the 21st century. At the start of the year, equity analysts had priced in profits growth of 5-10% a year, now they are downgrading their profits estimates by 5-10% a week. One of the deepest economic recessions since the 1930s will expose some well-known and some less well understood imbalances, whether economic, political or financial.

The coronavirus has created a major shock to the Chinese economy in the near-term, and as the virus has spread East to West the size and duration of the shock on both China and the global economy has risen. Disentangling the shock between the manufacturing and services sectors helps to illustrate the impact. It also reveals the potential for sharper than normal spillovers between countries. Overall, while the near-term corona shock may be very large, we expect that it will not derail the global economy; however, risks of a worse outcome remain high, even with supportive measures by policy makers.

The better news is that the policy response is faster and larger than would have been thought possible. As and when the pandemic is brought under control, then the conditions are falling into place for at least a moderate, possibly a rapid, recovery in activity. However, even though financial prices will benefit, this will not be a return to the world we once knew. Long-term implications are manifold, including what sorts of assets to buy to protect portfolios or benefit from the upside.

What is the economic outlook?

We may have passed the point of maximum panic in financial markets but yet to reach the point of maximum pessimism in terms of the economic statistics. All the evidence is pointing towards the deepest global recession since the 1930s. The lockdown of societies is causing many companies to rapidly lay off staff. In the US, jobless claims soared by 3 million in a single week. Nowcasts, real-time indicators of activity, and historical comparisons all suggest that the downturn seen in Q2 2020 could be of the order of 25%. The assessment of our Chief Economist and team is that global GDP will decline by over 8% in 2020. On the assumption that commercial activity is revived from the second half of the year, we expect a sharp snap back in 2021 with GDP growth of 12%. However, there is already permanent damage to the global economy from the corporate failures and collapse in capital spending. Hence by 2022 there will be a noticeable shortfall from previous trend growth of about 3%. We would emphasise the wide confidence limits around such forecasts at this stage.

Although we know that a deep recession approaches, the length and depth are still very uncertain. This partly depends on medical matters – how effective is the containment policy, does antibody testing work, will a second wave of infections appear? It partly depends not just on the size but especially on the efficacy of the policy responses from governments; policymakers are trying to protect jobs and cashflows, but will bankruptcies, bond defaults and layoffs be reduced to a manageable number? It partly depends on whether new shocks appear to test the economic system – the recent collapse in oil prices is not a help in that regard, placing the US shale industry in a bad place. Therefore, estimates about a U-shaped recovery, or a V, or a W, or some other combination, are purely guesses at this stage. It is not our central case, but policy errors could still lead to a credit crunch and an extended balance sheet recession and permanent stagflation. One of the noticeable differences between the crises in 2020 and 2008 is that too many countries are coping with their problems individually. There is little of the co-operation seen in 2008-09 by the G20; indeed, the pandemic is aggravating already difficult geopolitical and strategic differences between the US and China.

Chart 1: The fastest bear market in history?



How much bad news is priced in?

The short answer is a lot but not necessarily everything. There was indeed a state of panic in the financial markets in mid-March. The realisation that the coronavirus would cause long lasting economic damage sparked a wave of distressed selling, in particular a crisis in dollar liquidity as many investors rushed for safe assets. The good news is that prompt action by central banks and finance ministries has stabilised the situation. The global official interest rate has fallen while the fiscal stimulus is approaching 3-4% of GDP, already exceeding the support seen in the 2008-09 financial crisis. A mixture of QE programmes, yield curve control and forward guidance should contain short-and possibly longer-dated bond yields for some years.

There are several reasons though why equity prices could re-test previous lows, as is common in a bear market. Efforts to contain the virus may fail. Emerging market economies have far weaker public health systems and far less fiscal flexibility to support workers and businesses. On top of that, the disagreements between Saudi Arabia and Russia are forcing the oil price below $20 per barrel, harming the finances of many exporting nations. Even if developed market policy programmes prove effective, they cannot prevent a sharp rise in bankruptcies and credit defaults. Policymakers may have stopped a crisis leading to a depression, but halting the normal flow of commerce still has serious implications for financial systems. Even if a peak market volatility has been seen, we expect elevated levels for some time to come, and lower than normal levels of trading liquidity, with implications for risk appetites.

Chart 2: Contributions to change in global fiscal impulse (2020)



Forecasts are offered as opinion and are not reflective of potential performance. Forecasts are not guaranteed and actual events or results may differ materially.

Are there any rays of sunshine?

It is darkest before the dawn. Although Europe and the US face difficult months, Chinese business surveys snapped back at the end of March and the authorities there are beginning to ease policy. It is far from the case that all the easing has been seen on the fiscal front; the US Congress is currently debating a fourth mega-package. We expect public sector deficits in many countries to approach 10% of GDP this year, taking debt/GDP ratios well above 100%. However, strong support from central banks, via general QE programmes or specific yield curve control measures, will ensure debt servicing costs are manageable, for the time being. On the medical front, the WHO indicates the peak of infections may be in sight in Europe, while antibody tests may start to show that parts of the population can return to work.

What are the long term implications?

Just as the 2008-09 crisis changed the ways in which we all work, borrow,lend or invest, we are already exploring the many ways in which this crisis and the political responses will have longer-term implications

Just as the 2008-09 crisis changed the ways in which we all work, borrow, lend or invest, we are already exploring the many ways in which this crisis and the political responses will have longer-term implications. The role of the state and in particular its relationship with both the corporate sector and its citizens is being transformed in a short period of time. Our research programme is focusing on such areas as the correct valuation approaches in an environment of very low interest rates for the foreseeable future but also sizeable dividend cuts, potential equity dilution from stakes taken on by the public sector plus stronger corporate regulation of key industries. A key aspect of such long-term returns will be the inflation backdrop. While in the coming year or two the large output gap means disinflationary pressures dominate, further ahead central bank monetisation of government debt is fraught with dangers.

Although we expect a rapid recovery in corporate profits into 2021 as commercial activity revives, there are questions about longer-term profits growth. Globalisation is likely to be rolled back; companies must reassess supply chains, which are now seen as overly complex, and build up spare inventory levels. Meanwhile, additional resources need to be put into such vital areas as healthcare, medical services and social spending. Another trend could be towards national champions and more local production of key items and services.

What to buy, where to invest?

The golden rule of investing is to buy low, and there are selective opportunities for investors at present. There is a role for duration in a portfolio, best served by longer-dated bonds as central bank actions anchor the front end of the curve close to almost zero interest rates. Even if the recession is only a few quarters, this will put considerable pressure on commercial property incomes, on top of which structural changes in how people shop, travel and work will add extra burdens. Developed economy assets should be overweight versus emerging markets, as the fiscal flexibility and firepower of many developed economies contrasts with the restrictions on many emerging market policymakers. In terms of styles, in a world of very low bond yields, equity income from quality stocks will become valuable.

How to buy depends on the flexibility of the investor and their risk appetite. Many retail investors are best served by regular purchases, pound cost averaging. Others will prefer to follow the simple maxim – buy what the central banks are buying. More sophisticated institutional investors may wish to play the short term trading cycles, in which case we warn of better buying opportunities ahead as the markets start to differentiate more between the winners and losers at company, sector or country level. The next phase of this crisis should lead to more granular investment calls and differentiation of outcomes. Long-term valuations certainly do suggest equities outside the US have considerable value. The premium offered by risk assets over government bonds is attractive. However, a quality bias, for example in terms of balance sheet strength and ability to resist dividend cuts, makes sense in the next phase.

In conclusion, now the market panic is over, the worst of the economic pain will start to be seen; and in a few months, hopefully weeks, investors will start to price in better news as the policy stimulus and medical efforts take effect. However, the aftershocks of this historic crisis will last for years, and long standing investment rules must adapt as the landscape will look very different on the other side of the valley.

Chart 3: Earnings Projection Scenarios (%)



Forecasts are offered as opinion and are not reflective of potential performance. Forecasts are not guaranteed and actual events or results may differ materially.


The value of investments, and the income from them, can go down as well as up and you may get back less than the amount invested.

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Risk warning

Risk Warning

The value of investments, and the income from them, can go down as well as up and you may get back less than the amount invested.