Working through the potential Covid-19 exit scenarios
15 April 2020 | Markets and Economy
By Peter Westaway, chief economist and head of investment strategy, Vanguard Europe
When and how will we exit this Covid-19 crisis economically? And how and to what extent will markets recover as we do?
With so much uncertainty still out there and little precedent to go on – at least in modern times – answering these questions is as much art as it is science.
But one thing is for sure: it starts and ends with the virus itself.
Most of you by now will doubtless be familiar with the charts that show the different paths of contagion across countries and how these are gradually (but variously) levelling out as social distancing measures and lockdowns are implemented. In the case of some Asian countries, and Italy and Spain too, the number of new cases appears to have peaked and is declining. In the UK, France and Germany they could yet peak in the next week or two.
What our chart below seeks to do is take it further by roughly extrapolating these curves, as shown by the dotted lines, to show what could happen in the weeks ahead.
And what it suggests is that life could normalise in Europe as early as the summer as the pandemic wanes and the mitigation measures are lifted. After all, we've already begun to see this in Wuhan, where the outbreak is believed to have begun.
Forecast daily new cases of Covid-19 (7-day averages, log scale)
Source: Macrobond, Johns Hopkins University, Vanguard ISG. Data as of 7 April 2020. Any projections should be regarded as hypothetical in nature and do not reflect or guarantee future results.
So there are some grounds for optimism, which is partly why markets have recovered in recent days.
But the simple reality is that we're not quite there yet. Rather than a glimmer of light at the end of the tunnel, it could be a false dawn. As we're starting to see in China, South Korea and Singapore, the danger is that a second wave of infection emerges.
In the absence of a Covid-19 vaccine (or even herd immunity), there are two possible ways out that could buy us some time: a rigorous process of testing and tracking sick patients to prevent further serious outbreaks and/or a ‘pulsing' approach, in which lockdown measures are relaxed and then re-introduced, possibly many times.
So what might all this mean for the global economy? Firstly, that a rebound is likely in the second half of the year after a deep, sharp global recession in the first half.
How sharp a rebound, though, is unclear as it will depend on the precise details of the virus exit strategies that are followed. It is also difficult to see many industries bouncing back sharply even as lockdowns are relaxed, especially those relying on face-to-face interaction.
So we now foresee a grinding, slow second-half recovery rather than the sharp V-shaped one that many were talking about early in this crisis. Whichever virus scenario plays out, we estimate that average global activity in 2020 will likely be anything from 2% to 10% lower than in 2019.
What about markets? Do they have further to fall or have they already reached their low point?
The honest answer is ‘I don't know'. But one way to consider this question is to compare recent share price falls with how markets behaved during and after the global financial crisis (GFC).
In that simple respect, there is certainly room for further declines. As the chart below shows, although global shares have fallen much more quickly, they haven't yet registered the 50%-plus falls we saw from peak to trough 12 years ago.
Global equity performance
Past performance is not a reliable indicator of future results.
Source: Bloomberg, Vanguard ISG. MSCI All-Country World Index. “Since GFC”, Oct 31 2007 = 100. “Since Covid-19”, Feb 18 2020 = 100. Data as of 7 April 2020.
On the other hand, even if the global economy recovers only slowly in the second half of the year, it will still likely be a faster recovery than the protracted loss of activity seen during the GFC. Back then the world faced a chronic debt crisis requiring lengthy treatment. This time it faces an acute external shock.
We're no doubt going to see some horrible earnings numbers reported by companies in the coming weeks, but even with a potential 20% hit to GDP in the second quarter it would be hard to rationalise the 20% fall in equity prices that we've seen so far on the grounds of the stream of future profits alone.
Instead, much of the recent fall in the market has been driven by a sharp rise in the risk premium. And we know that risk premia have a tendency to mean revert.
That suggests the market ought to correct at some point. When exactly, though, is anybody's guess.
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The value of investments, and the income from them, may fall or rise and investors may get back less than they invested.
Past performance is not a reliable indicator of future results.
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