Special Halftime Report, Part 2

07-23-2020
Special Halftime Report, Part 2

Part 2: The second wave and the shape of recovery

 

At its midpoint, 2020 is already a year for the history books. But what could lie ahead for the remaining half? Last time, we looked at the question of why the stock market seems disconnected from the broader economy. This time in our “2020 Halftime Report,” we tackle the next two of the seven most pressing questions from our clients.

Question 2: What about a second Covid-19 wave? Isn’t that the real risk here?

Our answer in preview may surprise some here: Future flare-ups will have far less impact on financial markets. This view is not based on predictions of vaccines or the virus’s trajectory (we will leave amateur epidemiology to others; financial markets are our beat). Rather, it is again based on behavioral psychology. Consider earlier this year when the threat of a possible pandemic finally pierced the public consciousness. Back then, most had not heard of the term “coronavirus.” The terror and mystique quickly put a choke-hold on financial markets as investors scrambled for clarity.

Today, a clearer picture has emerged. More is known about the virus. Equipment and protective gear are in ample supply in most places. Testing capacity has increased dramatically, and contact-tracing is being ramped up in many countries. Firms and consumers have also adjusted to life in a pandemic. Working from home is now a feature of corporate life (kudos to all the parents with young children). Restaurants are delivering more. Grocery stores have facilitated curb-side pickup. Global business has adapted.

All this means changes from further outbreaks will be less disruptive than the first lockdown. Behaviour has already shifted. And the conversation has turned towards the risk and return tradeoff of draconian lockdowns and public policy. Fresh outbreaks in Beijing and, more recently, in the southern and western U.S. states underscore this point.

Even with further flare-ups, lockdowns in both cases have been more selective. An “abundance of caution” has been replaced with a more informed and less suppressive approach. That means a rerun of the severe economic contraction witnessed earlier this year (especially when the virus ravaged northeastern states) is highly unlikely. And, importantly, market responses have been more muted — indiscriminate liquidation and financial panic has not been correlated with recent outbreaks. In the case of China, its stock market (now the best performing in the world year-to-date) has seen an almost uninterrupted rise since bottoming in late March.

Question 3: Is a V-shaped recovery still possible?

For those cut from Panglossian cloth, there is a temptation to believe that, after a short intermission, the curtain will be drawn, light will shine on the stage, and the global economy will spring to life. Sport will return to stadiums. Air traffic will again fill our skies. And, for single people, the ice age of dating will quickly thaw (no doubt, with gusto). Collectively, the world will stagger blinkingly back to normal.

This view is best characterized by the letter “V”. But is this alphabet-soup debate really a helpful framework? Pandemic time runs at a snail’s pace. Our perceptions of daily movements disproportionately impact our view of the future. Was that data point you saw before lunch evidence of a U or a V? Or was it a Nike swoosh? Matching the symbol to the future economic trajectory is an exercise in futility.

A more helpful approach requires a longer-term perspective and an answer to the fundamental question (which we posed back in March): Is the virus a transitory shock or a catalyst to a longer running downturn? Skipping to the bottom line, we have strongly held the view that it is the former.

The key is to differentiate a temporary liquidity and demand shock from a classic recession (a longer-running change in trend driven by monetary tightening or the bursting of a major financial imbalance). To date, the weight of the evidence continues to suggest that this is more of a technical recession.

Consider past episodes. The 1930s depression was a classic credit crunch, exacerbated by counterproductive policy measures and protectionism. The bursting of the technology bubble in the late 1990s had its root in financial excesses and capital overspending. The crisis in 2008 was a perfect storm with the bursting of a major asset bubble and years of financial deleveraging afterward. What do all of these have in common? Deep financial imbalances that took years to work out.

Comparatively, the terrain upon which the virus landed is much different. Heading into 2020, the degree of leverage in the global financial system was far less than 2008. No major imbalances were evident (with some exceptions like Canada, which continues to cling to its status as a country with an epic consumer debt bubble). Households in the major economies such as the U.S. and Eurozone had deleveraged substantially since 2008. Most of the leverage in the U.S. corporate sector was on the financial engineering side rather than capital overspending. And banking systems around the world were generally healthy. Global systemic risks were in fact quite low. That makes Covid an unlikely catalyst to a longer-running downturn.

Another issue seems completely lost in the conversation. Recent statistical drops in the first and second quarter of 2020 (GDP, earnings and so on) are alarming and depressionary-like. But these are not the numbers of a classic downturn driven by market forces. Rather, they are the direct result of mandated public policy. What else could one expect in a full global lockdown? The virus is the problem, not the economy.

To be sure, the above view does not lead us to blind optimism. Yes, the second half is likely to witness a big growth rebound from deeply depressed conditions. But global demand will not revert serenely back to its previous trend line. Nor will there be an “all clear” announcement for the economy. The path to restarting the economy will be a series of starts and stops, with different regions opening on different timelines with different policy approaches. Yet, changes in trend matter most. To date, almost all incoming data points toward a steady return to growth – V-shaped or not.

Next time: Will central banks turn off the fire hose? Plus, our longer-term macro views.

Tyler Mordy, CFA, is President and CIO for Forstrong Global Asset Management Inc., engaged in top-down strategy, investment policy, and securities selection. He specializes in global investment strategy and ETF trends. This article first appeared in Forstrong’s March 26 issue of “Ask Forstrong,” available on Forstrong’s Global Thinking blog. Used with permission. You can reach Tyler by phone at Forstrong Global, toll-free 1-888-419-6715, or by email at tmordy@forstrong.com. Follow Tyler on Twitter at @TylerMordy and @ForstrongGlobal.

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