Sarasin's Guy Monson on the likely long-term impacts of the crisis.
The peak of the US stock market was as recent as 19 February. The average time to enter a bear market is 136 days. This time, it took little more than 20 trading days. For investors, the speed of decline is particularly disorientating.
However, three things are worth remembering. First, the 27% fall from peak for the world equity index probably discounts much of the damage, and the impact will ultimately be temporary. Second, the government and central bank response will be massive. The fiscal response could be very large, with chancellor Rishi Sunak’s aggressive and confident UK Budget potentially becoming something of a global template.
Finally, central banks and regulators learned a great deal from the last crisis about the value of liquidity and business continuity, and we expect very proactive measures to support the financial system.
Looking forward, the Covid-19 crisis will surely leave longer-term scars on the world economy and we must expect, at best, an L-shaped recovery across many regions. The damage in Europe will be concentrated in the service sectors – tourism, accommodation, travel and retail – where output is not easily recovered. Attitudes to social distancing will also take time to reverse, and it is very difficult to anticipate how long it will take consumer behaviour to normalise.
However, these behavioural changes also promise exciting new priorities for the global economy – potentially more home-working, greater awareness of biodiversity, support for truly universal healthcare, and a massive drive for digital and cloud-based business models. These are all welcome and thoroughly investable outcomes.
Massive fiscal programmes will also transform public services and infrastructure, while much of the implementation will occur in the long-term framework of a carbon-neutral global economy. For investors, these opportunities offer a promise of sustainable profitability and dividend growth that will underpin portfolios in 2021 and beyond, against a backdrop where much of the economic damage expected over the next 12 months is already reflected in this month’s sharp equity market declines.
Opportune entry point
The global economy is temporarily powering down, as Covid-19 containment measures restrict activity and curtail demand across an increasing portion of the globe. The impact is synchronised and transmitted as both a demand and supply shock. In the former, demand falls sharply as consumers and businesses worldwide defer consumption, travel and capital expenditure. In the latter, supply contracts, as capacity is shuttered, labour restricted and supply chains disrupted as part of the “containment phase” of the crisis.
Our base case is for global growth to fall to 0% in 2020, driven by sharp contractions in Q1 and Q2, followed by only a modest recovery in the second half of the year. We do not expect a V-shaped recovery in the second half. Instead, the global economy will experience a permanent loss, as services not consumed in the first half of the year will be lost – café-goers will not drink twice the amount of coffee next month. We also expect a weak form of “social distancing” to continue in the second half of the year as a result of “scarring” from the health crisis.
Finally, there will be a fear of a cash-flow and liquidity squeeze as business contracts, suppliers go unpaid, and lay-offs rise. In this respect, it is unhelpful the collapse in world oil prices has been greatly exacerbated by a supply war between two of the largest producers – Saudi Arabia and Russia. This adds further stress to credit markets, where the high leverage of the US shale producers is particularly vulnerable. At present, credit spreads have widened but are not yet approaching the levels we saw in 2008-09. We expect policymakers and central banks to focus on limiting spread widening in core markets and initiate targeted lending programmes of the sort Germany has just announced, which focus on the cash-flow squeeze for small and medium-sized businesses.
The suddenness in price moves can be explained in part by the sharp realisation of how dire the impact of containment strategies will be on global GDP. Therefore, markets may already have discounted much of the likely impact of the downturn. While we are not calling a market bottom, today’s valuations for high-quality, liquid and broadly thematic stocks incorporate a lot of bad news.
If we are right and we ultimately rebuild a new, more robust world with better global healthcare and sustainable infrastructure, with government bonds around the world yielding less than 1%, investors can afford to wait in the equity of companies central to achieving this vision.
Guy Monson, chief investment officer at Sarasin & Partners.