Shaping Up the Road Ahead

The global epidemic has led to the great lockdown which hit global economies hard. Unemployment soared, supply chains were distorted and global markets were dragged lower. According to the International Monetary Fund (IMF), this is being considered as the worst economic downturn since the Great Depression. Yet, the recent emergence of positive news related to developments of a possible cure and the relaxation of certain health measures, led to a rally in the global equity markets, some of which increased at a faster pace than others and beyond what most of us were expecting. Despite the equity market comeback, economic activity will take longer to pick up.

We have read about the billions of tax payers’ money distributed back to citizens in forms of financial aid supporting the hardest hit individuals and businesses. Thanks to swift and coordinated monetary and fiscal policy measures, together with the relaxation of some health measures, risky assets recovered a big portion of the previously lost ground. It is evident that markets tend or try to anticipate economic data.

A V-shaped economic recovery would bring a sharp dip in economic activity matched by an equally hurried surge back to normality. This assumes that the downturn would only last a short period. Despite all the negative headlines some support this view. Morgan Stanley boosted its call for a “sharp but short” recession ending by 2021 as economies strive to return back to pre-pandemic output levels. In fact it assumes that the world economic output will contract by 8.6% this year, swinging back to positive territory in 2021.

The US Federal Reserve and the IMF are not as optimistic as some market participants are. A fortnight ago the IMF stated that the economic forecast for June is very likely to be worse than the previous month. Meanwhile, the Federal Reserve’s Chairman Jerome Powell cautioned that the labour market is in for a “long road” to recovery and that policymakers also expect near-zero rates to last through 2022 to ensure a smooth rebound.

If the cure takes longer than expected and the world is hit by the second wave of infections, we shall be faced with a W-shaped economic recovery. This will in turn bring additional lockdowns and more economic uncertainty. The occurrence of such a double-dip recession is rare, with only two occurring in 1937-38 and 1981-87, both caused by fiscal policy changes.

Rather than experiencing a V-shaped economic recovery as some expect in the US, the recovery in Europe is expected to be more prolonged and the European Union is set to face an L-shaped economic recovery rather than a V-shaped one, as the relaunch of economic activity will be gradual. The economic recession which followed the financial crises of 2008, from which some western economies have not yet recovered, is a case in point.

The Spring Economic forecast issued by the European Commission stated that the economy will contract by 7.5% in 2020, but is expected to rebound by 6% in 2021. The EU and euro area growth projections have been revised lower by around 9% compared to the Economic Forecast for Autumn 2019. The shock to the European economy is symmetrical in that the pandemic has hit all member states, but both the decrease in output in 2020 and the strength of the 2021 rebound are set to vary markedly.

The prolongation sentiment in going back to normality is felt on businesses as a recent survey by Ernst and Young found that 54% of companies believe that a U-shaped recovery is likely. In a U-shaped economic recovery, it takes many months, if not years, for the economy to gain ground. The long, flat stretch of sideways growth comprises the bottom of the U-shape. The last decade was a good example of a U-shaped economic recovery.

Despite the global economic distress, the international equity markets are showing otherwise. After weeks of continuous battering on the global markets, and having reached a low during the last week of March, markets such as that in the US have almost fully recovered or in some cases surpassed pre-COVID levels. Market volatility is here to stay as markets will try to anticipate economic data, which comes in at a lag. In the meantime investors should not confuse a market recovery with an economic recovery.

Julian Mangion, B. Com ICWIM, is an Investment Advisor at Jesmond Mizzi Financial Advisors Limited. This article does not intend to give investment advice and the contents therein should not be construed as such. The Company is licensed to conduct investment services by the MFSA and is a Member of the Malta Stock Exchange and a member of the Atlas Group. The directors or related parties, including the company, and their clients are likely to have an interest in securities mentioned in this article. Investors should remember that past performance is no guide to future performance and that the value of investments may go down as well as up. For further information contact Jesmond Mizzi Financial Advisors Limited of 67, Level 3, South Street, Valletta, on Tel: 2122 4410, or email [email protected]