Following the mid March outlook on the COVID-19 health and economic crisis, J.P. Morgan has released more detailed analyses concerning the global economic growth.
The uncertain path and implications of the COVID-19 virus and the yet unknown impact of unprecedented global monetary and fiscal policy responses to the pandemic have resulted in an extremely wide range of economic expectations. Most likely reality will unfold between the best- and worst-case scenarios.
In a nutshell, economists expect a Q2 plunge in economic activity with a rebound in late 2020, followed by roughly trend-line global growth in 2021.
The expectations rest on an extrapolation of the general contours of the COVID-19 epidemic and its related economic experience to-date, along with the belief that global monetary and fiscal policy have been and will continue to be robust as well as supportive.
The most globally exposed equity markets are unlikely to fall significantly below levels seen in March. For a number of asset classes, any further material weaknesses could be viewed as buying opportunities.
Technology, health care, financials, extended credit, China and Asia equity are viewed as some of the potential beneficiaries of the environment ahead.
Pandemic and policy impact uncertainty allows for a wide range of outcomes
Visibility on the future of the global economy is cloudy at best. U.S. and European COVID-19 infection rates have not yet peaked. So, the full economic impact of the virus remains unclear. On the positive side, it is impossible to quantify the extent to which unprecedented monetary and fiscal policy responses can bend the economic trajectory. The result is a range of available forecasts that extends from a deep recession to full recovery within the next 12 months.
Still, economic extremes seem unlikely. Instead, investments analysts anticipate a late-2020 rebound followed by roughly trend-line global growth in 2021. The massive stimulus being injected into the global economy may provide a positive growth kicker in 2021 and beyond. This is based on the outcome from the prolonged impact of stimulus programs put in place as a response to the great financial crisis.
Investment funds managers generally expect continued extreme volatility in economies and asset markets in the near term. The absolute magnitude of the projected economic and employment dislocations will likely be jaw-dropping to investors. In certain markets it may catalyze a round of profit taking in the weeks ahead. Market participants will continue to take volatility as an opportunity to reposition and prepare for the post-COVID-19 environment, which will have some of the same characteristics as the pre-COVID period. Economic disruption and the “new economy” sectors will continue to encroach on the brick and mortar economy.
Key considerations influencing global economic growth
Most current outlooks are encouraged by the Chinese experience in dealing with COVID-19. Depending on how you define its start date, the crisis in China has progressed from quarantine to negligible infection rates in roughly two months. This approximate experience is shared across other Asian countries, most notably South Korea, Taiwan and Japan.
- Read more: How South Korea Contained COVID-19 Outbreak
With a later start date for COVID-19 in the West and, at least initially, a slower-to-act and less-effective command and control approach to quarantines, the virus peak in the U.S. and Europe will happen within weeks, not months, as a viable working projection.
At this time, at seems that the stimulus plans introduced globally are enough to prevent more than a one-quarter plunge in economic output. Also, it looks like equity prices at the lower end of March’s trading range reflected market expectations of a Q2 fall-off in real GDP.
The debate as to whether the economic turnaround following the viral peak will have a “V”, “U” or “L” shape hinges on whether the stimulus programs accomplish their purpose or lose potency in their execution. This is the source of real concern. But policy makers appear to have a clear grasp of the magnitude of the problem. It is clear by now that “whatever it takes” attitude should prevail. Further adjustments through additional stimulus packages, liquidity provisions and lending facilities should be forthcoming, as needed.
A reasonable estimate would be for a strong late Q3 or early Q4 economic revival mimicking the very strong snap-back in China where both service and manufacturing PMIs are in expansionary territory after their collapse in February.
How will risk markets perform over the next few months?
Economists expect that the lows have probably been reached for the most globally exposed equity markets. There is marginally more upside left in the countertrend rally, within the context of extreme volatility. History has shown, however, that major bottoms are not events but rather processes. As such, a retesting of mid-March market lows may take place. The magnitude of the economic decline expected in Q2 and uncertainty around growth in the second half of the year may shake investor confidence and catalyze a round of profit taking in the weeks ahead.
The Endowments & Foundations CIO team believes the COVID experience and the responses of policymakers will likely serve to accelerate changes already afoot in the global markets, particularly around new economy spending, rethinking the role of core fixed income and the value that real assets may play in a diversified portfolio. Central bank activism and fiscal policy responses are likely to be semi-permanent fixtures furthering the ultra-low interest rate environment and perceptions around economic stability and growth.
Against that backdrop, going forward, a greater investor attention to and improved valuation for certain segments of the economy is expected. Technology, health care and financial stocks, extended credit and China and Asia equity are some of the potential beneficiaries of the environment ahead.
Health care: Health care stocks offer an attractive combination of strong fundamentals, defensive earnings and cheap valuations. They remain significantly undervalued, trading near a 10% discount to the market, despite superior fundamentals that remain driven by innovation, increased adoption and global penetration.
Technology: Technology stocks are increasing their fundamental advantage relative to the market. The sector provides the vision and solutions that businesses and individuals need to overcome physical immobility. While other industries are shackled to the contour of a recovery, technology will likely continue compounding its impressive financial gains and accelerate toward a new digital economic frontier.
Financials: After serving as the epicenter of the 2008 global financial crisis, banks are now positioned to be part of the solution rather than the problem. Fortress balance sheets, excess capital and much improved management teams are not reflected in current valuations that indicate a 40%-50% discount to the market. In 2008 banks were weighed down by regulatory pressures and fragile capitalization structures. Today their exceptional balance sheets combined with unprecedented monetary and fiscal policy should allow them to significantly outperform implied expectations.
China/Asia: The effectiveness of the COVID-19 response and the noticeable rebound in the economy, albeit from a low base, should make China and most of Asia attractive investment destinations in the year ahead.
High yield: Credit stands out as an interesting opportunity, considering how wide spreads have risen above Treasuries. In the high yield market, spreads (approximately 900 basis points as of this writing) have narrowed but still discount recessionary conditions and look attractive on the margin.
As economists consider the wide range of potential outcomes for the global economy and markets over the course of 2020 and beyond, experience shows that this time is not likely to differ from previous crises. No doubt there is an existential dimension to the current crisis on top of the economic and financial issues. Structural changes already underway in the global economy will likely continue to accelerate as a result of the virus and its aftermath. But in an age of policy activism, health care innovation and acute attention to the concerns of the average consumer, it is fully expected that solutions will be found, bringing the economy and markets back to some semblance of normal if not accelerated growth.
