26 March 2020

Coronavirus: economic impact and strategy to adopt

Luc Charlier

Luc Charlier


As coronavirus impacts financial markets, discover the analysis of our experts

Watch the analysis of Ruben Smets.

The economic outlook is revised downwards…

After a period of total uncertainty and extreme difficulty in developing economic forecasts, the evolution of the pandemic, but also the publication of the first economic data, in China as elsewhere, allow us to gradually come up with estimates on the magnitude of the shock that this pandemic represents, and to develop slightly more accurate economic forecasts. At this stage, there are two main guidelines:

  • On the one hand, since the only measures to slow down the pandemic to date are the containment and limitation of travel, and this for several weeks, the economic impact of the pandemic is enormous. Indeed, the first indicators published for the month of March show a significant drop in consumer and business confidence in European countries, even though the pandemic had not yet shown its full extent during the measurement period. It is very likely that April will show an even worse situation in terms of confidence. Furthermore, data from China show that during the containment period, consumption can fall by more than 20%, as can industrial activity. We therefore expect a major impact on economic activity in both the first and second quarters of this year.
  • On the other hand, because the containment period extends over several weeks, but also because not all countries are affected at the same time, the recovery phase is expected to be slow. While at first a return to normal after a short period of containment could reasonably be imagined, another scenario must now be considered. While there will be a period of rebound as activity and consumption pick up, supply chains will take time to normalize, companies will remain in difficulty and economies will be structurally affected by the current crisis. This is therefore not a sprint, but a marathon, both medically and economically
… but the response is finally getting organized
  • That said, while the economic scenario must take into account the magnitude of the shock, it must also consider the economic policies implemented to counter it. With few exceptions, the authorities take the full measure of the shock. This is clearly the case for monetary policy: central banks act quickly and (very) strongly, both to ensure continued financing of the economy (through financial markets in the United States and through the banking sector in Europe) and to enable governments to meet unforeseen expenses at a lower cost. While the situation seems to be under control in the euro zone, the game is not yet won in the United States. Despite massive central bank intervention, the money market (which is an essential link in the financing of the economy) remains under pressure. The risk of a financial crisis cannot yet be ruled out, even if the monetary authorities react much more quickly than in the past.
  • Finally, in the fight against the consequences of the pandemic, it is necessary to stress the emergency and recovery plans of the different governments, in order to cushion the shock. Excluding the guarantees provided by governments, most European countries have already committed the equivalent of 2% of their respective GDP (even 4.5% in Germany) in additional resources. To this must be added the expenditure incurred "automatically" by social security systems. This is a very important safety net.
  • To conclude, the scale of the pandemic forces us to once again revise our economic forecasts downwards. We expect a sharp contraction of GDP in 2020 in most of the countries covered by our analysis. In the case of the euro area, it is almost certain that the loss of activity will exceed that experienced during the financial crisis. But the response of governments and central banks will cushion the shock somewhat and probably strengthen the recovery, which was sorely lacking in 2009.
Over time, central banks and governments should win the day!
  • Pinning hopes for a fast and lasting bounce in markets on massive stimulus from governments and central banks? While no two episodes are the same, that is not what happened during the financial crisis. Expectations were high in October 2008, with Federal Reserve interest rates hurtling toward zero and Congress passing a $700 billion bailout package for the economy. Alas, none of it helped in the stock market, at least right away. Shares fell for another four months, piling up 40% of losses before they began to rebound.
  • There are differences, of course, between the financial crisis then and the economic disruption today. But for investors wondering how firmly to embrace any rally, the parallels are enough give pause. If nothing else it shows what a mistake it can be to use daily or even monthly reactions in markets to judge a program aimed at shifting the economy. Even a nearly 10% rally in two days doesn’t mean a market will go up in a straight line. It is too early to ask for a quick fix.
  • The MSCI World All Country index has wiped out all of the gains (40%) accumulated since its Christmas Eve 2018 low. With that support line gone, and signs mounting that the effects from the coronavirus will lead to a recession, international investors are now recalibrating where the current pain may halt in the equity market.
  • While the risk of further sharp declines appears to be limited as global stocks have fallen more than 25% from their 2020 peak and credit risk premium have widened substantially, market volatility might continue in financial markets. Uncertainty over the global economic and medical outlook is still too great to justify indiscriminate buying risk assets right now.
  • The next wave risks to be profit warnings. With an ever-increasing number of countries around the world essentially bringing their economies to a halt, analysts are struggling to gauge the impact on corporate profits. Forward earnings estimates for the MSCI World All Country Index have dropped 6.5% this month alone to 1.8%. It is certain that further cuts to profit estimates will continue to weigh on markets.
  • Besides the obvious metric - a peak in new cases - we are highlighting the following as among potential measures for a turnaround on the stock market: a stabilization in funding markets, fiscal packages seen as sufficient enough and coordinated to avert mass bankruptcies, and a pharmaceutical development that offers a solution to the health crisis.
  • For now, we still recommend to favor, either directly or through a fund, stocks and bonds of the least indebted and least affected by the health crisis companies.
  • But over time, central banks and governments should win the day. Share moves in China - once the heart of the outbreak - could offer clues about the bottom of the sell-off. Stocks in the country have outperformed in the global market meltdown that began in late February, as it passed the peak in new coronavirus cases. The Shanghai Composite Index is down about 13% on the year, while the S&P 500 Index and the Stoxx Europe 600 Index have plummeted more than twice as much!
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