Mar 26th 2020

Coronavirus and the global economy: yes, there really is cause for optimism

by Arturo Bris

 

Arturo Bris is Professor of Finance at  the International Institute for Management Development (IMD)

 

 

Stock markets are rebounding on the back of the newly agreed US$2 trillion American fiscal stimulus plan. It comes after a week that was the worst in history for the Dow and many others around the world. My impression is that the unfolding global recession has now been fully priced into stocks by investors.

That recession looks all but guaranteed, of course: Chinese GDP is estimated to have dropped 12% in the first two months of the year – a harbinger of what is coming everywhere. One useful guide is the market for corporate default swaps, which are financial instruments that investors use to hedge against companies running into trouble. The Markit iTraxx Europe Crossover index, which tracks European corporate swaps, is implying a 38% probability in European companies defaulting on their debts in months to come.

Yet let’s put things in perspective. The coronavirus is certainly causing a tragic loss of human lives, but the mortality rate appears to be lower than some early predictions indicated.

So what will be the economic impact of the lockdown measures required to keep the mortality rate down? A large part of the fallout to date – particularly on stock markets – has actually been from negative sentiment rather than real effects. The Baltic Exchange Dry Index, which measures the average price of moving raw materials by sea, is the best indicator of global trade in real time. It bottomed out in February and has since improved as the China crisis has receded – per the chart below.

Arturo Bris

It’s also interesting to compare the 2008 and 2020 market crashes. I have calculated the number of days to the lowest market level in 2008 and 2020, relative to the last previous day when stock markets were at the same level. For example the US stock market bottom of March 9 2009 was the lowest point since September 12 1996 – 13 years or 4,561 days earlier. The low this time, assuming it is not exceeded, was last seen on July 7 2016 – less than four years ago. The chart below confirms that this pattern has been seen in most markets around the world.

Arturo Bris

Assessing 2020

My late colleague Professor Stewart Hamilton was IMD’s specialist in financial crises. He used to quote the famous economist John Kenneth Galbraith, who said: “There can be few fields of human endeavour in which history counts for so little as in the world of finance.”

This certainly applies to 2020. Whereas 2008 was about a collapse in demand, the coronavirus is causing collapses in both supply and demand. It is not a banking crisis, at least not for the time being, so many corporations will hopefully be able to rely on bank credit, over and above government rescue packages. The economic impact is also apparently different across countries.

Interestingly, the stock market impact has been more severe on value stocks, meaning mature companies that attract investors by paying dividends, not because they are seen as having great potential for growth. Compared to the so-called growth stocks, such companies typically have lower ratios between their stock market prices and earnings (PE ratio).

The chart below shows different sectors along the x axis and shows their average PE ratios in the blue bars. The sectors towards the left, like airlines and finance, are value stocks. Those on the right, such as technology and healthcare, are growth stocks. The red bars show what has happened to their average share prices – in other words, how far they have fallen.

Arturo Bris

What it shows is that the growth sectors’ shares have declined the least. This is strange because in a financial crisis, investors tend to rely on stocks that provide value today. As finance economists say, “in winter we burn fat”. To me, this indicates light at the end of the tunnel; that companies who you would expect to generate growth, will still generate growth.

Seven recommendations

I know I am playing the optimist here, and the coming days may take me back to a different reality. But let us at least assume that we have seen the worst and it is now time to think about the after-crisis. What can be done?

  1. Governments and central banks have been quicker to respond than in 2008, but some sectors need more support than others. States need to encourage banks to lend and be flexible, taking advantage of ultra-low interest rates.

  2. Many are calling the crisis a black swan event, meaning a cataclysm that has caused great economic hardship and could not have been foreseen. But such a pandemic was expected in 2017. Policymakers can therefore use the data from this crisis to plan for future crises. Companies should learn from what has worked best and permanently make it part of their values: making employee safety their top priority, for example.

  3. The world will become less globalised now. Companies must adapt their supply chains and markets to protect themselves in the event of a repeat. That means refocusing on their home markets as much as possible now, and striking a new, safer balance between local and global after the crisis is over.

  4. The 2008 crisis had a massive impact on corporate investment from which we have not yet recovered, since the banking crisis meant that banks were unable to lend. Since 2020 is not about a banking crisis, companies will emerge strongest if they avoid under-investing.

  5. Government policies will determine how well companies can come through. So more than ever, the private sector must cooperate. It is not the time to complain about government, but to collaborate.

  6. Planning for different possible outcomes from this crisis is useless. It was the same in 2008. It is better to be resilient and reactive, and to focus on what is happening now.

  7. Finally, the best acquisitions are made in bad times. So for those companies that have the means, it is a good time to think about mergers and acquisitions because deals will be cheap.

Arturo Bris, Professor of Finance, International Institute for Management Development (IMD)

This article is republished from The Conversation under a Creative Commons license. Read the original article.

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More Current Affairs

May 23rd 2020
EXTRACT: "Not all aspects of our near and medium-term future can be foreseen at this juncture of the Covid-19 pandemic, but we now know enough to make some hypotheses about what is likely to change, based on what has already changed. The future is sure to look very different than it did before this decade began, regardless of whether a vaccine is found. If a vaccine is found, it is unlikely to be tested, approved, manufactured, and efficiently distributed to the world’s population of nearly 8 billion people for years. Bearing in mind that there is no vaccine for any coronavirus, what is likelier is that the world will be living with Covid-19 as a part of our ecosystem for many years to come – possibly permanently. That means that our new normal is probably already here."
May 21st 2020
EXTRACT: "LONDON – The new Franco-German proposal for a €500 billion ($547 billion) European recovery fund could turn out to be the most important historic consequence of the coronavirus. It is even conceivable that the deal struck between German Chancellor Angela Merkel and French President Emmanuel Macron might one day be remembered as the European Union’s “Hamiltonian moment,” comparable to the 1790 agreement between Alexander Hamilton and Thomas Jefferson on public borrowing, which helped to turn the United States, a confederation with little central government, into a genuine political federation."
May 19th 2020
EXTRACT: "In April 2011, Donald Trump, then considering a run for the presidency the following year, said that he had sent investigators to Hawaii to check out rumors that President Barack Obama wasn’t born there, but in Kenya, which would disqualify him for the presidency. His investigators, Trump declared, “cannot believe what they’re finding.” I can find no record of Trump being challenged on this outlandish claim at the time. In the fall of 2016, Trump, now the Republican presidential nominee, was convinced by his staff that he had to abandon this “birther” nonsense. He did so reluctantly, charging – also with no evidence – that such rumors had actually been initiated by his opponent, Hillary Clinton. There, in a nutshell, is Trump’s modus operandi: he’s not just a liar but a fabulist, seemingly unconcerned with whether his fictions will be exposed. If they are, the world simply moves on as he invents fresh distractions."
May 19th 2020
EXTRACT: "Li, a doctor, was purportedly silenced and chastised by Chinese officials for warning on December 30, 2019, about a new virus in the Wuhan hospital where he worked. When it became evident that he was on to something serious – so serious, in fact, that it ultimately killed him – the Chinese government changed its tune and celebrated Li’s bravery. If only that had happened sooner, the argument goes, the world would have avoided this horrific pandemic.................... But that’s not what happened."
May 9th 2020
EXTRACT: "Jana Winter and Hunter Walker at Yahoo News broke the story that 11 Secret Service agents have tested positive for the coronavirus. Likely some of them served in the West Wing. This week it was revealed at that a US military valet who brought Trump food came down with the virus, sending Trump into a “lava level” rage. Two aides to Vice President Mike Pence have tested positive. Some observers are afraid that the virus is circulating in the West Wing itself."
May 6th 2020
EXTRACT: "There has been much debate around the world about the source of the COVID-19 pandemic, ranging from a laboratory to Wuhan’s seafood market to some other form of animal-to-human transmission. While there is no proof (yet) that the virus may have been inadvertently released from one of the two biological research laboratories located at Wuhan, there is evidence that viral release has occurred in the past, and a host of additional data that point to a laboratory connection. "
May 4th 2020
EXTRACT: "A better bet is that nothing will be the same. Wealth will be destroyed on a catastrophic scale, and policymakers will need to find a way to ensure that, at least in some cases, creditors take part of the hit, a process that will play out over years of negotiation and litigation. For bankruptcy lawyers and lobbyists, it will be a bonanza, part of which will come from pressing taxpayers to honor bailout guarantees. Such a scenario would be an unholy mess."
Apr 29th 2020
EXTRACT: "We need the twenty-first century’s two superpowers, America and China, to set the example, by burying their rivalry and uniting all of humankind around a collective response to the current crisis, and to those that await us. As COVID-19 has taught us, the old international system can no longer guarantee humankind’s safety and security. We cannot afford to be taught that lesson twice."
Apr 29th 2020
EXTRACT: "It should come as no surprise that Trump has abused his power in orchestrating the federal response to the pandemic. For example, he made sure that Colorado received 100 much-needed ventilators, and made sure that Colorado voters knew it, in order to help re-elect troubled incumbent Republican senator Cory Gardner.  More alarming, Trump effectively threatened to wage germ warfare against US Postal Service workers by denying them congressionally approved virus-mitigation aid unless the USPS quadrupled rates on packages. Trump’s actual target was Jeff Bezos, the CEO of Amazon and owner of The Washington Post."
Apr 28th 2020
EXTRACT: "These ten risks, already looming large before COVID-19 struck, now threaten to fuel a perfect storm that sweeps the entire global economy into a decade of despair. By the 2030s, technology and more competent political leadership may be able to reduce, resolve, or minimize many of these problems, giving rise to a more inclusive, cooperative, and stable international order. But any happy ending assumes that we find a way to survive the coming Greater Depression."
Apr 26th 2020
EXTRACT: "In response to the COVID-19 pandemic, the US Federal Reserve will buy unlimited quantities of Treasury bonds, the Bank of England will purchase £200 billion ($250 billion) of gilts, and the European Central Bank up to €750 billion ($815 billion) of eurozone bonds. Almost certainly, central banks will end up providing monetary finance to fund fiscal deficits. The only question is whether they should make that explicit."
Apr 25th 2020
EXTRACT: "Even if you’re not enamoured with creepy crawlies, their gradual disappearance from the places they were once numerous is an ongoing crisis for the natural world. Insects and small invertebrates occupy the bottom rungs of most terrestrial ecosystems. As ecologist E.O. Wilson once observed, if you take away the “little things that run the world” then most of the creatures occupying niches further up the food chain will disappear too, and that includes humans. That’s why a 2017 study in Germany rang so many alarm bells – it reported a 75% decline over 27 years in the local biomass of all kinds of flying insects."
Apr 24th 2020
EXTRACT: "By 2000, China had already established near monopoly status on the manufacture of a whole range of products that the world rapidly consumes. Just a decade ago, 91% of all personal computers, 80% of all air conditioners, 74% of global solar cells, 71% of cell phones, and 60% of all cement were being manufactured in China. The world was hooked on Chinese-made products and the Chinese government had its way with foreign companies choosing to manufacture goods there, enforcing many draconian operating requirements in an environment that most companies would never have agreed to endure anywhere else."
Apr 20th 2020
Extracts: "Long before people and goods were traversing the globe non-stop, pandemics were already an inescapable feature of human civilization.........Nearly two millennia before London’s Great Plague, during the epidemic that killed at least one-third of Athenians near the end of the Peloponnesian War.............Epidemics not only ravage economies, but also throw societal inequalities into sharp relief, deepening deepen mistrust in the status quo........... Machiavelli, who witnessed – and probably died in – the plague in Florence in 1527, viewed the outbreak as the direct result of misrule. Criticisms of China, Trump, British Prime Minister Boris Johnson, and others have echoed this sentiment....Others view epidemics through the lens of conspiracy theories. Marcus Aurelius blamed the Christians for the Antonine Plague. In Christian Europe, the fourteenth-century Black Death was blamed on the Jews......Despite these similarities, the COVID-19 pandemic is likely to stand out in a crucial way: it is unlikely to upend the established order. The Antonine and Justinian Plagues encouraged the spread of Christianity throughout Europe. The Black Death drove people toward a less religious, more humanistic view of the world – a shift that would lead to the Renaissance. The Spanish flu prompted uprisings, massive labor strikes, and anti-imperialist protests; in India, where millions died, it helped to galvanize the independence movement."
Apr 17th 2020
EXTRACT: "From peddling disinformation about the virus to disbanding the National Security Council directorate overseeing pandemic threats, Trump has squandered multiple opportunities to get ahead of the COVID-19 crisis. The health and economic consequences that we are now experiencing have long been predicted. US intelligence analysts were warning about precisely this scenario for at least 12 years. But even they could not foresee that America would end up with a president willing to sacrifice so many lives on the altar of his ego."
Apr 9th 2020
EXTRACTS: ".........[1] The average bankruptcy takes 260 days to work out. During that period, businesses will have a hard time rebuilding.......[2]...consider the complexity of the global supply chain. More than 90% of Fortune 1,000 companies have at least one tier-2 (secondary) supplier in Hubei, the Chinese province around Wuhan.........[3]...disturbingly, 40% of all US corporate debt was rated BBB, just above junk, going into the crisis, while only 30% of the world’s outstanding stock of non-financial corporate bonds were rated A or above..........[4] Despite central bank interest-rate cuts, borrowing costs for companies are now rising dramatically. With further downgrades from credit ratings agencies all but guaranteed, especially with many big earnings announcements due after Easter, some companies will lose access to credit altogether. Moody’s estimates that the default rate for junk-rated companies could hit an astounding 10%, compared to a historical average of 4%......[5]...flu vaccines are relatively ineffective. They reduce your risk of becoming ill by 40% to 60%, compared to 97% for measles vaccines and 88% for mumps........[6] Lockdowns might end, while other measures like social distancing, limits on gatherings and travel restrictions continue – perhaps on a seasonal basis......[7] South Korea could be a glimpse into the future. It has so far avoided an Italian-style health crisis without a lockdown, but has still imposed various restrictions on the economy."
Apr 8th 2020
EXTRACT: "A recent study, published in the British Medical Journal, suggested that 78% of people with COVID-19 have no symptoms. The findings are in line with research from an Italian village at the epicentre of the outbreak showing that 50%-75% were asymptomatic, but represented “a formidable source” of contagion. A recent Icelandic study also showed that around 50% of those who tested positive to COVID-19 in a large-scale testing exercise were asymptomatic. Meanwhile, a WHO report found that “80% of infections are mild or asymptomatic, 15% are severe infections and 5% are critical infections................The new BMJ study is seemingly different to the findings of studies from earlier in the pandemic, which suggested that the completely asymptomatic proportion of COVID-19 is small: 17.9% on the Diamond Princess Cruise Ship and 33.3% in Japanese people who were evacuated from Wuhan.”
Apr 8th 2020
EXTRACT: "Spooked by COVID-19, Americans not only stripped supermarket shelves of toilet paper and pasta, but also drove gun sales higher than ever. Apparently, many of these recent gun buyers never purchased a firearm before. Lobbyists for the US gun industry want gun stores to be counted as “essential” businesses, like food shops and pharmacies. A number of states have readily complied, as has the Department of Homeland Security. Jay Pritzker, Governor of Illinois, declared that “firearm and ammunition suppliers and retailers, for purposes of safety and security” should indeed be allowed to continue supplying these alleged necessities."
Apr 8th 2020
EXTRACT: "........until the health crisis is resolved, the economic situation will look exceedingly grim. And even after an economic restart, the damage to businesses and debt markets will have lingering effects, especially considering that global debt was already at record-breaking levels before the crisis began..............Given that the 2008 financial crisis produced deep political paralysis and nurtured a crop of anti-technocratic populist leaders, we can expect the COVID-19 crisis to lead to even more extreme disruptions. ............it is possible that stock-market losses so far have been less than those of 2008 only because everyone remembers how values shot back up during the recovery. But if that crisis does turn out to have been a mere dry run for this one, investors shouldn’t expect a quick rebound."
Apr 5th 2020
EXTRACT: "We are feeling the anxiety effects of not one pandemic but two. First, there is the COVID-19 pandemic, which makes us anxious because we, or people we love, anywhere in the world, might soon become gravely ill and even die. And, second, there is a pandemic of anxiety about the economic consequences of the first. These two pandemics are interrelated, but are not the same phenomenon......................a contagion of financial anxiety works differently than a contagion of disease. It is fueled in part by people noticing others’ lack of confidence, reflected in price declines, and others’ emotional reaction to the declines. A negative bubble in the stock market occurs when people see prices falling, and, trying to discover why, start amplifying stories that explain the decline. Then, prices fall on subsequent days, and again and again."