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Review & Outlook: a record expansion comes to an abrupt halt - what lies ahead?


Caspar Rock

Caspar Rock

Chief Investment Officer

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Within weeks a health crisis rapidly turned into an unprecedented economic crisis – with seismic consequences, which are still unfolding. At the time of publication France, Spain and Italy are in lockdown, with the UK applying similar measures more recently.

Schools in over 100 countries, including the US, have been closed. No economy could experience shocks of this magnitude without significant damage.

Schroders’ economists currently expect a contraction in world GDP of just over 3% in 2020 (see chart below), the worst outcome since the 1930s. Investors fear that shutting down of much of the global economy in response to the health crisis will result in a collapse in consumption and widespread corporate distress.

The problem, as former US Treasury Secretary Larry Summers put it, is that “economic time has been stopped, but financial time has not”. Rent, interest payments and wages are all mounting up – while cash flow is set to fall sharply, at least temporarily.

Contributions to global growth by region

p5_worldGDP_w600px.png

Source: Schroders

This is the conundrum that central banks and governments around the world are struggling to solve. They need to find a policy response that will “mothball the economy”, a solution that will allow businesses and individuals to cope until economies can resume functioning at a more normal level.

Sentiment has not been helped by the collapse in the oil price in early March. Just as the coronavirus started to have an impact on indicators of future global growth, major oil producers were widely expected to agree on an output cut which would support prices. However, geopolitical wrangling between Russia and Saudi Arabia led to a very different outcome, with the latter announcing it would ramp up production. Oil prices have fallen to the lowest level since the 1980s.

This toxic cocktail of economic shocks and extreme uncertainty has taken a heavy toll on global equities. When it became clear that the virus was fast spreading beyond China's borders, investors took fright. Over a few short weeks, major global equity indices fell into a bear market (defined as a 20% fall from the peak). Despite a recovery towards the end of March, they remain 20% to 30% below the highs of the year.

Valuations are certainly far lower, but that does not necessarily mean they are stable or indeed easily measurable: there is huge uncertainty about future earnings, cash flows and dividends.

The policy challenge

The difficulty for policy makers is that the tools they normally use to handle an economic slowdown are not well suited to the current crisis – and markets know it. Stocks have experienced some of their steepest falls in the wake of central bank interventions, as investors worry that monetary policy can do little to protect the economy from efforts to contain the pandemic.

Even so, major central banks are trying everything in their power. They have quickly applied the lessons they learned in the financial crisis of 2008-09, with measures designed to ensure market liquidity and encourage the flow and fair pricing of credit. The problem is that these tools largely rely on the financial sector to transmit stimulus to the real economy. This takes time, which is not a luxury necessarily available to small businesses or individuals with immediate cash flow requirements.

Governments have been quick to recognise this problem. The UK, France and other European countries have introduced measures including loan guarantees, tax cuts and cash grants to small businesses, which should provide faster relief. The UK has announced income replacement for individuals in a process to be administered by HMRC. The US has announced its own significant measures. Speed will be critical to the success of these initiatives as the benefits must reach their intended recipients before too many jobs and businesses are lost.

Looking to the recovery

Key to recovery will be bringing the pandemic under control and ending the restrictions in force across much of Europe and the US.

The good news is that this is now happening in Asia (see pages 10-11). This has been achieved with restrictions on movement, but also with much more widespread use of testing. And while a vaccine is still some way off, regulators are looking at existing drugs that could be used to treat coronavirus. If these can reduce the strain on national healthcare systems, there will be less need for such draconian measures to prevent its future spread.

The recovery will also depend on policy makers’ ability to protect their economies through any shutdown over the next few months. If they are largely successful, economies should be able to recover rapidly, boosted by the powerful stimulus measures from central banks and governments. Schroders’ economists expect growth to rebound to in excess of 7% in 2021.

The opinions contained herein are those of the author and do not necessarily represent the house view. This document is intended to be for information purposes only. The material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The material is not intended to provide, and should not be relied on for, accounting, legal or tax advice, or investment recommendations. Information herein is believed to be reliable but Cazenove Capital does not warrant its completeness or accuracy. No responsibility can be accepted for errors of fact or opinion. This does not exclude or restrict any duty or liability that Cazenove Capital has to its customers under the Financial Services and Markets Act 2000 (as amended from time to time) or any other regulatory system. Cazenove Capital is part of the Schroder Group and a trading name of Schroder & Co. Registered Office at 1 London Wall Place, London EC2Y 5AU. Authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority. For your security, communications may be taped and monitored. 

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