Recent developments have led to a drastic downward adjustment of our economic growth projections. There is a widespread consensus that the economic impact will be severe, but other than that uncertainty prevails. Therefore, we identify three different ways in which this crisis can evolve, ranging from a relatively short duration of lockdown measures (six weeks) and a subsequent quick economic recovery, to an extended duration of lockdown measures (12 weeks) and a subsequent slow recovery. This results in global growth projections ranging from -1.5% to -7.2% for 2020.

Even our most optimistic scenario foresees that some of the upcoming negative effects have so far not been fully discounted by financial markets. We expect more negative earnings revisions and poor economic news, volatile markets and negative investor sentiment. Therefore, we maintain our cautious stance and remain underweight in equities and neutral in bonds.

Recent equity market rebound seems premature

Global equity markets experienced their worst quarter since the global financial crisis in 2008. Nevertheless, in the last week of March and the beginning of April equities rallied, as investor sentiment was supported by newly announced monetary and fiscal stimulus measures and a reduction in newly confirmed coronavirus cases in some regions. There is hope amongst investors that the bottom has been reached, and that this will be the start of a ‘V-shaped’ recovery in equity markets. In our view, however, the current market bounce is only temporary.

An assessment of the current situation shows that the peak of global infection cases still lays ahead. The lockdown in most countries will therefore continue. This, in turn, means that we should reckon with deteriorating economic data and more negative earnings revisions. Furthermore, as described in our previous outlook - Corona unveils the fragility of our economic system, the potential impact of an extended aftermath of the demand shock and the possibility of feedback loops should not be underestimated. We do not think that the financial markets have fully discounted all these upcoming negative effects yet.

Also, with respect to financial markets, the current crisis cannot be treated as an isolated temporary disruption. Already before the corona outbreak, the global economy was approaching the end of the economic cycle, with global growth hoovering below trend. Investor sentiment was bullish, and equity valuations were unrealistically high, driven by an ultra-loose global monetary policy stance and a record-amount of corporate share buybacks. Corporate bond yields, on the other hand, had reached record-lows in a search for yield.

In our view, the pandemic has merely acted as a catalyst to reverse some of these extremes, eventually leading to some form of normalisation. Therefore, a ‘V-shaped’ recovery seems unlikely. We foresee a more gradual path to normalisation. For the time being, this implies that the current bear market is likely to find new lows, as the full depth of the crisis still must be priced in.

Country-specific characteristics determine excess vulnerability

The overall economic impact of the coronavirus crisis depends upon lockdown measures and policy measures. A country’s sectoral composition is important when assessing the initial fall in economic activity due to the imposed lockdown measures. A country’s need for fiscal policies and its available fiscal space determine the eventual shape of economic recovery. Below we outline the most important considerations:

  • Lockdown measures can be broken down into two components that determine the eventual economic impact:
    • The severity of the lockdown determines the initial fall in economic activity and is of course mostly influenced by the severity of the outbreak and the necessity of stringent lockdown measures. All countries will to some extent experience the basic global shock that will severely impact economic growth. However, when assessing which countries are most vulnerable, their sectoral composition comes into play (see chart below). Lockdowns are having a disproportionate effect on countries that have relatively large business and consumer services sectors, as these sectors are particularly affected. Especially industries such as tourism, travel, hospitality and entertainment have felt the effects of the lockdowns heavily and instantly.For this reason, unemployment may increase substantially more than in previous recessions, which were triggered by slowdowns in the manufacturing sector, as the services sector is far more labour intensive. The recent surge in US unemployment claims to a record-high of 6.6 million for the week ending March 28 confirms this expectation.
      Countries with large public services (healthcare and administration) and communications sectors, on the other hand, are likely to reap the rewards from their sectoral composition, as these sectors are set to benefit from higher government spending and shifting patterns in demand.
      As for the manufacturing sector, the most affected industries are those most dependent on global supply chains, such as the automotive industry. This implies that countries with large manufacturing sectors are more exposed to lockdowns implemented in other countries.
    • The duration of the lockdown determines the amount of structural problems that might arise, as a prolonged duration of lockdowns can lead to bankruptcies and long-term unemployment. This, in turn, would trigger aftermath demand shock effects, resulting in undesired feedback loops. The duration of the lockdown measures to date remains the great unknown when assessing the eventual economic impact for both the aggregated world economy and individual countries. Growth projections are therefore out of necessity based on assumptions.
Source: Triodos IM, based on Capital Economics
  • Policy measures can be broken down into monetary and fiscal components. Both can’t do much about the initial fall in economic activity due to lockdown measures. Emergency policy measures can nevertheless support the financial system and economy to prevent the initial slowdown from turning into a more structural issue:
    • Fiscal policies: As explained in our previous outlook, fiscal policy emergency measures should focus on absorbing the economic impact of the coronavirus crisis as much as possible, thereby making sure that companies and households get through the lockdown period with the least damage. This would allow the economy a more favourable starting position once the lockdown measures are lifted and the focus shifts to longer-term fiscal policy decisions. This notion has been felt by many governments, as fiscal emergency packages have been scaled up to unprecedented levels.
      The total value of fiscal policies (as a % of GDP) needed per country first and foremost depends on the size of the outbreak and the subsequent severity of the lockdown measures. However, it also depends upon the quality of a country’s healthcare system, its social security system and its institutions. More fiscal stimulus will be needed in countries that have limited safety nets. Up till now, the announced fiscal packages are larger than those implemented during the Global Financial Crisis. The fiscal leeway varies greatly amongst countries, but in combination with accommodative monetary policies, currently there is no stress in financial markets about the coming wall of debt that must be absorbed.
    • Monetary policies: Monetary policies are needed to complement fiscal policies, to ensure that there is indeed enough liquidity available to ease any stress in short-term funding, to address disruptions in financial markets and to ensure that the financial system remains stable and continues to function.To date, all major central banks have taken substantial and unprecedented measures. However, there is a limit to the superhuman monetary powers of central bankers. Therefore, we think that the country-specific overall economic impact will mostly depend on the size, speed and efficiency of fiscal policies.

Three basic shapes of economic recovery

The elements discussed above set the scene for the eventual shape of the economic recovery. This recovery can take multiple forms, and the eventual outcome mostly depends upon the duration of the lockdown and the status in which the global economy finds itself once the lockdown measures can be (gradually) lifted. Basically, there are three different possibilities for economic recovery:

  • No permanent loss of output – return to pre-pandemic growth trend: This type of recovery would imply a large loss of output during the lockdown, all of which would almost immediately be fully compensated once the measures are lifted. To us, this so-called ‘V-shaped’ recovery seems unrealistic, as a substantial part of consumer spending, such as travel and leisure, will not be compensated and therefore result in some permanent loss of output.
  • Permanent loss of output – return to pre-virus growth trend: This type of recovery would imply a large loss of output during the lockdown that would not be completely recovered once the measures are lifted. However, in the long run we end up at the same level of growth as we would have had, had the corona crisis not taken place. This could happen in the form of a ‘V-shaped’ recovery, or at a slower ‘U-shaped’ pace, depending on the effectiveness of the implemented fiscal policies. Old patterns would re-emerge, and as would, eventually, the old status quo. This seems a likely outcome.
  • Permanent loss of output – no return to pre-virus growth trend:This type of recovery would also imply a large, permanent loss in output, but on top of that would mean that we never return to the growth trend from before the coronavirus outbreak. This could happen either because of lasting damage to the supply-side of the economy, or lasting weakness in the demand-side, or a combination of both. In the most extreme case, this would imply an ‘L-shaped’ recovery. A global resurgence of the coronavirus later in the year would set the scene for this outcome.

All countries suffer, but weaker economies bear the brunt

Country-specific elements determine the shape of economic recovery. Here, we discuss the most important of these elements for the world’s key regions. Next to the severity and duration of the lockdowns, vital elements are a country’s sectoral composition, its available fiscal space, the quality of its healthcare and social security systems and institutions:

  • China: A rather limited fiscal stimulus package equal to 1.4% of GDP (2019) has been announced. We think the real fiscal stimulus will come from infrastructure funding, as there are plans to boost infrastructure spending with 10%. If China really has successfully contained the spread of the coronavirus, the overall economic impact could potentially be relatively modest in comparison to other countries. Forceful additional stimulus in the infrastructure sector would be vital, however. Without this additional fiscal stimulus, the recovery may take much longer, as an ongoing lockdown in other countries will have a negative impact because of China’s large position in the global supply chains.
  • Japan: Japan has recently confirmed a fiscal emergency support package of JPY 108 trillion (~ 20% of 2019 GDP), of which JPY 39 trillion has been reserved for direct fiscal spending. The total amount likely includes earlier significant stimulus that was already agreed upon to counter last year’s sales tax increase and the US-China trade war.Containment measures in Japan so far have been less severe than in the US and the eurozone. Recently there has been an increase in newly confirmed cases, however, which could potentially lead to more stringent measures, or even a lockdown. So far, we think that the outright decline in economic growth could be less severe than in other developed countries, although the dependency of its large manufacturing sector disproportionately exposes Japan to global supply chain interruptions.
  • Eurozone: There is a great deal of discussion between EU member states on the necessity of a forceful centralised response. So far, the issuance of eurobonds and the activation of the European Stability Mechanism (ESM - the EU common rescue fund) have been blocked by Northern European countries, as they are reluctant to contribute to funds that will be mostly used to support their Southern European counterparts.
    Germany, the eurozone’s largest economy, has implemented a fiscal stimulus package of considerable size, with amongst others EUR 156 billion of direct stimulus for small businesses and the self-employed (4% of 2019 GDP) and a EUR 500 billion bail-out fund. Southern European countries such as Italy and Spain, on the other hand, have a much higher debt burden than their Northern counterparts, which limits their fiscal policy options.
    The severity of the implemented lockdown measures is likely to cause a large outright decline in economic growth in the eurozone. This could be amplified by Germany’s dependency on its manufacturing sector, even though France has a relatively favourable sectoral composition due to its large public and social services sector. A coordinated response seems necessary to prevent an eventual slow economic recovery. However, so far, the inability to come up with a joint forceful policy package makes a slow recovery most likely.
  • United Kingdom: Targeted coronavirus fiscal support measures are estimated to be around GBP 70 billion (3.2% of 2019 GDP), and GBP 18 billion (0.7% of 2019 GDP) are longer term investment measures. In comparison to other developed economies, the UK’s public debt ratio is relatively low, providing the country enough room to absorb the economic impact of the lockdown measures. However, the economic recovery is likely to be severely hampered by the extra burden that will result from Brexit. The combined economic impact can’t be completely absorbed by even the largest of fiscal policy packages. Therefore, it might take a long period of time for the UK to return to pre-outbreak levels.
  • United States: A USD 2.2 trillion stimulus package was agreed upon (~ 10% of 2019 GDP). Of this, USD 250 billion is used for direct income transfers, i.e. traditional direct expenditure stimulus, while the rest is intended to replace lost income or provide lending facilities.Taking the rapid spread of the coronavirus and the initial slow government response into account, we think that the outright decline in economic growth will be substantial. This decline will be amplified by the record-low oil prices as a result from the Russian-Saudi oil price war, which will hurt the substantial US shale gas sector. However, the overall economic impact could theoretically be somewhat less severe. The US could benefit from a relatively quick recovery due to the implemented fiscal policies and sectoral composition, if the country provides additional stimulus to support laid-off workers in case of an extended lockdown period. If this does not happen, the US economy will feel the effects of its traditionally limited social safety nets. Also, if the oil price war goes on for an extended period, this would be a drag to the economic growth recovery.
  • Emerging countries – ex China: The coronavirus has recently seen a rapid spread in emerging economies. Some countries, like Iran, India, Nigeria and South Africa have already implemented severe lockdown measures. For other countries, we expect that lockdowns will also be implemented soon.
    Less developed healthcare systems, a high dependency on informal employment and unfavourable country-specific sectoral compositions make emerging economies disproportionately vulnerable and make a severe outright decline in economic growth probable. Oil-producing emerging countries will be even worse off, as they see their oil revenues dampen due to the recently escalated oil price war. This analysis can be extended to other net commodity exporting countries, as commodity prices in general are declining due to lower demand resulting from coronavirus disruptions. The global risk-off mode related to the pandemic also has negative indirect effects, for example through reduced capital flows to emerging markets and depreciating local currencies.
    So far, the fiscal policy response varied per emerging country, with rather modest measures in India and Mexico and more sizeable measures in Brazil. In general, the weak global growth over the last few years has made sure emerging economies have little room for forceful long-term fiscal policy packages. This implies a slow economic recovery for most emerging countries.

All scenarios project a severe global recession

In order to assess the potential impact on economic growth, we have made three basic scenarios that differentiate on the duration of the lockdown measures and the subsequent length of the economic recovery (also see chart and table below):

  • Short lockdown – quick economic recovery: The lockdown measures in each country last on average six weeks, after which a quick recovery will take place. For 2020, an annual economic growth rate of -1.5% is projected, for 2021 we project a growth rate of 5.0%. In this scenario, The US and the UK will experience the lowest economic growth rates in 2020, and the growth of the UK will also stay behind in 2021 due to Brexit. Japan will experience a relatively modest fall in growth in 2020 and a sharp growth pickup in 2021. China’s growth pickup in 2021 will be relatively modest compared to other regions.
  • Short lockdown– slow economic recovery: The lockdown measures in each country last on average six weeks, after which a slow recovery will set in. For 2020, an annual economic growth rate of -1.8% is projected, for 2021 we project a growth rate of 3.6%. In this scenario, the US and the UK will again experience the lowest economic growth rates in 2020, but now the US will experience the most modest growth pickup in 2021. China’s yearly growth rates are least affected by the slower pace of the economic recovery.
  • Longer lockdown – slow economic recovery: The lockdown measures in each country last on average 12 weeks, after which a slow recovery will set in. For 2020, an annual economic growth rate of -7.2% is projected, for 2021 we project a growth rate of 3.6%. In this scenario, the eurozone, UK and US economies will all decline by more than 10%. China’s growth rate for 2020 will also turn negative. The longer lockdown will have a relatively more severe impact on the economic growth rates of the eurozone and the UK in 2021, with the UK set for negative growth rates in both 2020 and 2021.
Source: Triodos IM

We need targeted green stimulus to break from the current paradigm

The corona pandemic ruthlessly exposes the inbuilt weaknesses in our economic system. Decades of singular focus on economic growth and financial market returns have overstretched our planetary boundaries and have substantially increased inequality. Our economic system has become very efficient but inherently fragile. It lacks buffers, where the problem now is foremost the absence of financial buffers. Weak government finances, optimised but highly leveraged corporate balance sheets, and flexible labour markets where people are living from one payslip to another make our system very vulnerable for a sudden stop in economic activity.

During a crisis of this size, it is of course important to implement emergency measures that facilitate the proper functioning of healthcare systems and avoid more structural problems (e.g. unemployment and bankruptcies). However, we must not forget that, although this crisis might be temporary, our economic system will remain fragile unless we consciously break from the current paradigm. When the time has come to rebuild our economy after the current crisis, monetary and fiscal policies should follow an investment agenda that supports the transition towards a more sustainable world. The focus should be on investments in climate mitigation and adaption and the fulfilment of the Sustainable Development Goals in the next ten years.

We are indeed in the middle of the greatest social and economic crisis since World War II. And because of its size and its impact, now is the time to think about longer-term green fiscal and monetary policies that are vital to achieve this drastic change in economic system. We simply can’t afford to put seemingly less urgent matters such as climate change, biodiversity loss and growing inequality on hold. In our next investment outlook update (to be published soon), we will present our ideas on how to best achieve a more robust, sustainable and inclusive economic system. 

Source: Triodos IM