Mazars Economic Update - May 2020
Covid-19 signalled the death knell for an 11-year economic expansion cycle, the longest and one of the shallowest in post-WWII history. It is the fist time in recent history when a shock exogenous to the economic system causes a severe recession. The downturn during the “Great Lockdown” is forecasted to be the biggest since the 1930’s. This period includes one world war, Vietnam, the Nixon Shock and hyperinflation, other epidemics, natural disasters or political turbulence.
- The IMF is currently forecasting -3% global growth and -6.5% growth in the UK for 2020
- Q2 data for the US (-4.8% Annualised GDP against expectations for -3.8%) already suggest that the hit is worse that expected, so risks are to the downside. Data collection is problematic as many companies remain shut down.
- The virus is slowing down. Consumer sentiment indices, earnings expectations as well as current forecasts, suggest confidence that the shutdown will be temporary in nature and the world will be completely over the lockdown by September.
- Individual economies (like the UK) are expected to move in lockstep with the rest of the world.
The Coronavirus Recession Monitor
The effects of such an unprecedented sudden “stroke” for the economy, even if fully revived at some point, are going to be felt for a very long time. Repercussions will vary between sectors. Hospitality and Travel are expected to take the biggest and longest term hit. Conversely, healthcare is a sector that will see renewed focus. The services sector, which mostly relies on face-to-face interactions, is expected to be challenged and face a transformation. Overall, the crisis will affect those companies that were more cash-strapped at its beginning.
We believe we have already entered the area of exponential consequences. That means that each day the economy remains shut, damage done is higher than one day’s GDP, and that is growing exponentially. As the quarantine cycle is unknown, so is the level of long term economic damage, that will affect business planning for 2020-2021. No multiplying factors exist to explain the relationship between quarantine days and GDP damage, as we have never had to shut an array of economic sectors so quickly in the past. Different scenarios don’t vary thus, as to the trough of the recession, but rather as to the shape and length of the recovery.
"Normality", as in a return to our ways in January 2020, may be a long time away for a generation that will probably not soon forget a 2-3 month home internment. Epidemics end with vaccines, not isolation, or even cure protocols. We are the very least 6 months away from a vaccine available to all, exactly as much away as we are from normality.
The simple truth is that not all businesses will survive the recession, the economic pressures and the change in consumer habits.
The latest cycle was underwritten by central banks. For capitalism to survive, the next cycle will have to be sustained for some time by both central banks (monetary policy) and governments (fiscal policy). The pendulum is due to swing away from liberal capitalism and back to a more state-centric model. International travel, including business travel, may be hamstrung until the end of the year.
Business survival over the shorter term depends on prior effective planning, cash flow availability and low operational costs. Companies with higher operational leverage may overall suffer more than those with more variable expenses. Larger companies overall have an advantage over smaller companies.
To gauge how the economy is performing we need to accept some limitations. The "hard data" indicating the damage take time to gather and by the time they are published they are already a snapshot of the past. Some data is even quarterly. Under usual circumstances that may have still been good enough to observe is whether the economy is moving at a certain trend or not. However, at a time of upheaval, with the economy in desperate search of a new trend, old data (even from February 2020) become largely irrelevant except maybe as anchors for the more current data. Thus, we must rely on more :"soft data": consumer and business sentiment indicators, stock analyst and purchase manager expectations and look at financial markets- a mechanism well experienced in gathering and quickly assessing large volumes of data. We must also follow the narrative regarding the virus progression and fear of people to go out, which may exacerbate economic stresses.
At this point, a lot of the lockdown damage does not show in many of the data. Surveyors have been reporting difficulties conducting surveys with so many businesses shut down.
Are Businesses Confident?
Businesses are already showing signs of stress.
Business sentiment has not been particularly good after a surge in global economic demand in late 2017, which was fuelled mostly by expectations for the Trump Tax plan in 2018. The economy was turbo-charged, but the spectre of slow growth continued to constrain business decisions. We see downturn in the data in Germany, the UK and the US based on March and early April data.
However, on the ISM March survey, US businesses were still optimistic their backlogs would increase, which means they expect more work to come. We expect that index to reverse in Apri, but if it doesn't it could signal resilience in US business sentiment, which usually has a tendency to spill over the the rest of the world.
Are Consumers Confident
Consumer confidence already sapping
Consumer confidence surveys around the world suggest that consumers are already feeling some of the uncertainty. However, as consumption is limited to basic consumer staples and job losses have not accentuated yet (which we fully expect to see based on some early indications from the US), consumers don't feel despondent.
We would expect consumer confidence to retreat fast in the next few months. The question is whether it will feed into a vicious cycle with business sentiment, where one is bringing the other down, or whether the positive narratives which will necessarily emerge, be enough to restore some confidence.
Another key indicator we intend to follow is savings. At this point they are relatively flat.The "paradox of thrift" suggests that the more consumers save the worst for the economy. Savings rates will be a very good gauge of consumer sentiment.
Economic Health and Liquidity
Position: Bankrupcy and consumer insolvency wave to come
Indices don't yet suggest a wave of insolvencies, as government measures to help the economy are still in place. We expect to see the true measure of the damage when various government programmes either expire or demand for money outstrips supply.
In the mean time we are looking at analyst Corporate earnings estimates. Although these typically represent listed (and thus larger) companies, they serve as a good yardstick for the broader economic slowdown.
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When it comes to economic health, the PMI indices, surveys of purchasing managers, represent some of the more current and forward looking data available. Readings over 50 signal economic expansion and below 50 economic contraction.
Currently all PMI indicators suggest sharp contraction, especially in the services sector, which usually comprises 70%-80% of developed economies and is most representative of smaller businesses, which are expected to be hit the hardest.
Earlier supply pressures, from China's lockdown have now become demand pressures from the economies it serves.
US purchasing managers were still optimistic about the future in March, but we would wait to see data from April and May before pronouncing judgment.
Position: Coronavirus Narrative Fizzles Out
The narrative is a very important "fear factor". We believe that it is impossible for the economy to restart if people are innundated on a daily basis with health warnings if they visit a restaurant.
We will not take the high road and assume information is a completely independent variable. In fact we fully expect governments to transmit "safety" signals accross all formal and informal communications channels in the next few months.
This is why we are monitoring both sides of the equation: Articles and Searches.
The narrative seems to have peaked around March. More importantly, this is when the "Recession" narrative peaked as well. The fact that they are both coming down is a good prognosticator that the "shock" phase is over and consumers are adjusting to new realities.
Virus Progression (Deaths per 1m, as of Apr 26 2020)
First wave is past its peak
We treat the Mortalities data with caution, as methodologies vary accross many countries, and governments are eager to embrace more positive narratives. However, a look accross the board suggests that the virus has peaked around 2 weeks ago in the UK and the US. The UK in particluar, as well as France, appear to follow Italy's curve, although in France, cases seem to descalate more quickly.
Both cases and mortalities curves seem to be flattening out, which suggests that the exploding phase of this first wave of the virus is probably over. Having said that, we wouldn't be too surprised if the virus rekindled, or if we saw a second wave around September.
The truth of the matter is that "social isolation" is a very extreme and short term measure. Without adequate testing (which is not really available ot most countries), a stable cure protocol and a vaccine, economic pressures and uncertainty will persist.
All sources: Refinitiv. The information contained in this document is believed to be correct but cannot be guaranteed. Opinions constitute our judgment as at the date shown and are subject to change without notice. This document is not intended as an offer or solicitation to buy or sell securities, nor does it constitute a personal recommendation. Where links to third party websites are provided Mazars Financial Planning Ltd accepts no responsibility for the content of such websites nor the services, products or items offered through such websites.
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