Recovery from the coronavirus-induced economic and financial market meltdown could take some two years, according to Prescient Investment Management’s research and baseline forecast.
The asset manager has outlined three different potential scenarios and their implications for asset classes and asset class returns. Their analysis points to a U-shaped recovery; however, it has never been more difficult predicting outcomes with any degree of certainty, and thus the V- and L-shaped recoveries are also essential to consider.
“The world is grappling with the worst plunge in economic output in living memory,” says Prescient Head of Asset Allocation, Bastian Teichgreeber. “The coronavirus pandemic, and the lockdowns to contain it, affect both supply and demand in the various sectors of the economy in unusual and different ways.”
He adds that while the scope and reach of the coronavirus crisis are unprecedented, Prescient has developed a range of scenarios to cover the potential roads to recovery we face and outlines what impact these will have on the economy and financial markets.
Looking back at a tough four months
After making new all-time highs as late as mid-February 2020, equity markets around the globe made headlines for the record pace at which they fell shortly after as a result of the global spread of the Covid-19 Pandemic. The price declines have been indiscriminate, with equities, listed property, bonds, credit, preference shares, inflation-linked bonds (ILBs), income assets, and the rand selling off in lockstep. Correlations moved to highs we have never seen before. During April and early May, however, we have seen a steep recovery, with markets posting record returns. The question that remains, given the global uncertainty around the coronavirus is where to from here?
The way forward
The world is grappling with the worst plunge in economic output in living memory. The coronavirus pandemic, and the lockdowns to contain it, affect both supply and demand in the various sectors of the economy in unusual and different ways. While the scope and reach of the coronavirus crisis are unprecedented, we investigate a set of scenarios to cover the potential scenarios we face and what impact these will have on the economy and financial markets.
The question everyone is asking is: How long will it take to return to the pre-corona GDP peak once the economy has hit bottom? Our base case, says Teichgreeber, is a U-shaped recovery in which losses incurred in the first two quarters of 2020 would be recovered within two years. “This might sound pessimistic to some and optimistic to others. The risks to our view are significant on the up and the downside.” Prescient outlines three potential scenarios and how these would take shape once the crisis passes and how they would impact investments. In addition, to the base case, the asset allocation team assesses a more optimistic scenario of a V-shaped recovery, as well as a more pessimistic scenario of an L-shaped recovery.
- A U-shaped recovery – base case
The base case assumes a slow increase in new infections throughout May, but also a levelling off of new infections after that. Says Teichgreeber: “We are convinced that the peak of daily new infections, certainly in Developed Markets, is now largely behind us.” This base case assumes a continued low mortality rate among the mostly elderly population. Should this be the case, Prescient expects a deep recession through the second and third quarters of 2020, based on an assessment of the virus’s fundamental impact, market reactions and the significant drag on economic activity globally. After that, a slow and gradual recovery is expected over the following months. Capital markets are expected to price in this recovery beforehand.
- An L-shaped recovery – the bear case
The bear case assumes a continued spike in new infections in the US and a Trump Administration reluctant to deal with the problem more proactively. This scenario could lead to a second wave of lockdowns around the world, coupled with a fresh upsurge in infections hitting those countries that remain behind the trend on infections. A global liquidity crisis would ensue, followed by a more prolonged economic downturn. Risky assets would sell off further into a second dip, and markets would be rattled by more volatility, eventually finding a floor at a much lower level than seen in March 2020
- A V-shaped recovery – the bull case
Prescient’s bull case is based on positive surprises, including a potential cure to the virus, more promising results in vaccine tests, national lockdowns already in place leading to low new infection rates while managing to minimise the extent of the economic slowdown. The improved global sentiment as a result of this more favourable prognosis leads to a sharp economic recovery, spurred by easy financial conditions and fiscal stimuli around the globe. Risky assets would return to their pre-crisis levels within the next 9 to 12 months in this recovery scenario.
In the chart below, Prescient illustrates these different scenarios and plots economic growth against trend growth. In the bear case, Teichgreeber doesn’t expect a return to trend growth anytime soon because of the extent of the economic damage and long-lasting impact on global demand.
The base case assumes the economic trough is reached towards the back half of the year. However, Teichgreeber does expect the recovery to be gradual. “In terms of our base case, we estimate it will take two years to return to trend growth.”
In our bull case, says Teichgreeber, we estimate a much quicker recovery. “We estimate that if a cure is developed soon, productive capital that has been switched off could be just switched on again. In this case, our estimated time to reach trend growth would be less than a year.”
PLEASE SEE GRAPH ON THE ATTACHED PRESS RELEASE.
Implications for asset class returns
Prescient outlines the potential impact these three scenarios could have on asset class returns in the tables below, with the disclaimer that they are based on our assumptions and thus subject to both upside and downside risks because outcomes during this crisis are particularly challenging to predict and subject to change.
PLEASE SEE TABLE AND GRAPHS ON THE ATTACHED PRESS RELEASE.
Looking positively into a post-corona world
With lockdowns being eased globally step by step, Teichgreeber says many activities that were switched off will be switched on again in lockstep. Still, some activities will be restrained for much longer.
Fiscal stimulus, as well as monetary policy, will partly offset some of the hesitations to spend by consumers and companies. Financial conditions will ease. However, an event the scale of the coronavirus pandemic will almost certainly have profound economic, financial and political effects that will be felt for a long time.
Says Bastian: “We do, however, remain optimistic. A crisis can be the mother of invention. The coronavirus shock is likely to spur innovation in many fields. In the long run, the resulting jolt to productivity may be more profound than the drags.”
