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

Mar 31st 2020
EXTRACT: "The absence of effective federal oversight and management of the COVID-19 crisis will undoubtedly be judged by historians as the biggest US governmental calamity of all time."
Mar 29th 2020
EXTRACT: " South Korea is one of the world’s most advanced countries........... But so, too, is the United States. Why, then, has the US lagged so far behind in its response to the pandemic? The short answer is that the US has a president who is fundamentally unfit for the job, both intellectually and temperamentally."
Mar 26th 2020
EXTRACT: "A large part of the fallout to date – particularly on stock markets – has actually been from negative sentiment rather than real effects."
Mar 24th 2020
EXTRACT: ".........every component of aggregate demand – consumption, capital spending, exports – is in unprecedented free fall. While most self-serving commentators have been anticipating a V-shaped downturn – with output falling sharply for one quarter and then rapidly recovering the next – it should now be clear that the COVID-19 crisis is something else entirely. The contraction that is now underway looks to be neither V- nor U- nor L-shaped (a sharp downturn followed by stagnation). Rather, it looks like an I: a vertical line representing financial markets and the real economy plummeting..............The risk of a new Great Depression, worse than the original – a Greater Depression – is rising by the day."
Mar 24th 2020
EXTRACT: "President Donald Trump and US policymakers have thus far favored piecemeal measures, especially when it comes to the state directing – indeed, reorganizing – the private sector. Their instinctive belief in the superiority of the market and private initiatives, regardless of the circumstances, leads them to recoil from the scale of government intervention needed to save our lives and livelihoods."
Mar 23rd 2020
EXTRACT: "Back in July 2019, while in Michigan for one of the early Democratic Party presidential debates, I was invited to a small dinner with Bernie Sanders. Toward the end of the meal, those who remained at the table included actor/activist Danny Glover, Dr. Cornel West, former Mayor Gus Newport, Jane Sanders, and a few key campaign staffers. What ensued was a free-flowing discussion of the agents of social and political change, sprinkled with personal recollections of and lessons learned from historical figures – many of whom had been known by my dinner companions.......I came away from that evening seeing Bernie Sanders in a different light. He was, and still is, a candidate for the presidency of the United States. At the same time, he must also be seen as a transformative figure in modern American political history."
Mar 15th 2020
EXTRACT: "Why are we more scared of what is less likely to kill us? The psychological principle that makes us fear swine flu, avian flu, or COVID-19, but not the common flu is called fear of dread risks. It is easy to elicit fear of episodes in which many people die within a short interval, such as plane crashes or epidemics. But when just as many or more people die over a longer period – as with car accidents or the seasonal flu – it is difficult to scare the public into wearing seatbelts or getting vaccinated."
Mar 11th 2020
EXTRACT: "But if containment measures fail – as we are seeing in Italy just now – the banks may still end up in trouble. They may also stop lending again, in which case the asset bubbles would collapse and a long-term recession would become a certainty. Central banks and governments would have to step in with more assistance: as well as further interest rate cuts, they look likely to try more QE and potentially bailouts like in 2007-09 if necessary. But given the limited scope this time around, if the global economy stalls for the long term, these measures might still fail and central bankers could potentially lose control of the marketplace altogether. In such a situation, we would be in truly uncharted territory." PICTURE BELOW: WORLD DEBT.
Mar 11th 2020
EXTRACT: "The Russian resistance appears to have derived from fears that if they cut back exports and OPEC managed to keep the price high, US petroleum firms using hydraulic fracturing (fracking) would simply rush in to grab Russian markets in Europe........So the theory that Russia provoked the price fall to harm US fracking companies is incorrect. They provoked it to avoid being harmed by the American producers, as they saw it."
Mar 8th 2020
EXTRACT: "I was recently walking along East 29th Street in Manhattan, after visiting a friend at Bellevue Hospital, when I was roused from my thoughts by a middle-aged white male screaming at an old Chinese man, “Get the fuck out of my country, you piece of Chinese shit!” The old man was stunned. So was I, before I bellowed back (deploying the full range of my native Australian vocabulary), “Fuck off and leave him alone, you white racist piece of shit!”  The pedestrian traffic stopped. A young white guy with dark hair came storming toward me. As a non-pugilist by instinct and training, I braced for what was coming. He stopped just short of me and said, “Thank you for standing up for him. That’s why I fought in Iraq; so that people like him could be free.” "
Mar 6th 2020
EXTRACTS: "Dreyfus was originally arrested and convicted on charges of selling military secrets to Germany – France’s historical enemy. But because he was a Jew, his guilt was assumed from the start, particularly by most of the French officer corps. To ensure that the charges would stick, various conspirators fabricated evidence against Dreyfus, including a secret file that only the judges who handed down the conviction and prison sentence were allowed to see........In the Dreyfus Affair, a savagely right-wing press fanned the flames of anti-Semitism and intrigue among elites, just as Fox News does today against Trump’s enemies. Owing to these malign efforts, truth itself becomes blurred,........Most depressing of all, though, is the fact that no senior figure in the US has come forward to stand alongside Vindman. There has been no Zola to issue the equivalent of the famous “J’Accuse!” pamphlet, shaming the country’s complicit elites for their lies and corruption. Instead, men like former Secretary of Defense James Mattis, former White House Chief of Staff John Kelly, and former National Security Adviser John Bolton have put their personal interests first, remaining mostly silent......"
Mar 5th 2020
EXTRACT: "After nearly four years of inveighing against the US intelligence officials and analysts who revealed Russia’s meddling in the 2016 US presidential election, Donald Trump is finally acting fully on his paranoia by carrying out a purge. "
Mar 3rd 2020
EXTRACTS: "........the next global recession could be around the corner – and that it may look a lot different from those that began in 2001 and 2008.........unlike the two previous global recessions this century, the new coronavirus, COVID-19, implies a supply shock as well as a demand shock. ..........In contrast to recessions driven mainly by a demand shortfall, the challenge posed by a supply-side-driven downturn is that it can result in sharp declines in production and widespread bottlenecks. In that case, generalized shortages – something that some countries have not seen since the gas lines of 1970s – could ultimately push inflation up, not down."
Feb 27th 2020
EXTRACT: "The EU must ask itself if it is prepared to do what is necessary to remain an independent player, united in the common interest of all Europeans. Otherwise, Europe’s viability as a democratic, sovereign entity in control of its own destiny will be called into question – and therefore tested by adversaries – like never before."
Feb 25th 2020
EXTRACT: "The world economy has clearly caught a cold. The outbreak of COVID-19 came at a particularly vulnerable point in the global business cycle. ...........This matters little to the optimistic consensus of investors. After all, by definition shocks are merely temporary disruptions of an underlying trend. While it is tempting to dismiss this shock for that very reason, the key is to heed the implications of the underlying trend. The world economy was weak, and getting weaker, when COVID-19 struck. The V-shaped recovery trajectory of a SARS-like episode will thus be much tougher to replicate – especially with monetary and fiscal authorities in the US, Japan, and Europe having such little ammunition at their disposal. That, of course, was the big risk all along. In these days of dip-buying froth, China’s sneeze may prove to be especially vexing for long-complacent financial markets."
Feb 25th 2020
EXTRACT: "It is becoming increasingly clear, however, that this new coronavirus is likely to do much more damage than SARS. Not only has COVID-19 already caused more deaths than its predecessor; its economic consequences are likely to be compounded by unfavorable conditions – beginning with China’s increased economic vulnerability.................So far, US investors seem unconcerned about these risks. But they may be taking too much comfort from the US Federal Reserve’s three interest-rate cuts last year. Should the US economy falter, there is nowhere near enough room for the Fed to cut interest rates by 500 basis points, as it has in past recessions."
Feb 18th 2020
EXTRACT: "Beyond the usual economic and policy risks that most financial analysts worry about, a number of potentially seismic white swans are visible on the horizon this year. Any of them could trigger severe economic, financial, political, and geopolitical disturbances unlike anything since the 2008 crisis."
Feb 18th 2020
Extract: "In late 2019, Zogby Research Services (ZRS) once again had the opportunity to poll public opinion across the Middle East and North Africa about many of these issues that are of such critical concern to the region and its peoples..............One of the more intriguing results in our 2019 survey were the changes in Arab views toward the Israeli-Palestinian conflict. Most Arabs still blame the US and Israel for the absence of peace and have little confidence that the conflict can be resolved in the near future. Maybe as a result of this despair, this issue now ranks low as an Arab priority. Also noteworthy is the fact that majorities in most Arab countries now say that normalization with Israel, which they acknowledge is already happening, may be a good thing. This development shouldn’t be overstated, however, since there is still no love for Israel. It appears, from our survey, to be born of frustration, weariness with Palestinians being victims of war, and the possibility that normalization might bring some economic benefits and could give Arabs leverage to press Israel to make concessions to the Palestinians."
Feb 15th 2020
EXTRACT: "Global dissatisfaction with democracy has increased over the past 25 years, according to our recent report. Drawing upon the HUMAN Surveys project, the report covered 154 countries, with 77 countries covered continuously for the period from 1995 to 2020. These samples were possible thanks to the combination of data from over 25 sources, 3,500 national surveys, and 4 million respondents. Not surprisingly, the gloomy headline finding – rising democratic dissatisfaction – attracted the most attention. Less widely discussed, however, is the “good news” – that a small sample of countries has bucked the trend, and have record high levels of satisfaction with their democracies."
Feb 14th 2020
EXTRACT: "This is how dictatorships begin. As the US prepares for its next presidential election in November, it is every citizen’s responsibility rationally to examine Trump’s dictatorial impulses, which reelection would only reinforce. It is not safe to assume that he won’t go too far, or that he is too much of a “mediocrity” – as Leon Trotsky called Stalin (an assessment with which many Bolsheviks agreed) – to transform his country......Vladimir Lenin, himself a ruthless Bolshevik, wrote in 1922 that, “Stalin concentrated in his hands enormous power, which he won’t be able to use responsibly,” owing to traits like rudeness, intolerance, and capriciousness. Trump has all of them in spades. The more power he concentrates in his own hands, the dimmer the long-term outlook for American democracy becomes. His reelection could mean lights out."