Slow, complicated and careful: What a reopening of the economy might look like
With a very healthy dose of humility, let’s take a look at what a reopening of the global economy may look like.
Data on coal consumption, railcar volumes, air pollution, etc., through early April all suggest China has been able to restore much of its factory output to more normal levels. Retail spending has been slower to come back online, however, even with most stores having already opened their doors.
In Europe, Denmark, Norway, Austria and the Czech Republic appear to be at the front of the pack in planning the restarts of their economies. These will be important litmus tests for the outlook in the broader developed markets.
Broadly speaking, we believe that an economic reopening will likely be defined by three key characteristics:
- It will be slow. For example, schools across Canada have been suspended or cancelled indefinitely, and in the United States, some states have closed their schools for the year through June. This could make it difficult for parents to fully return to their offices.
- It will be complicated. For instance, which businesses are deemed essential services are different for each province, as are the quarantine rules. In the U.S., New York state is coordinating with Connecticut and New Jersey on a regional get-back-to-work plan, given the interlinkages of their transit systems and economies.
- Done correctly, it will have to be careful. Rigorous testing, safeguarding vulnerable populations and a staggered approach will be likely, if not required.
In other words, the switch won’t be simply flipped from off to on again overnight. The global economy’s transition back to a relative state of normalcy will be slow. But it will be a transition nonetheless—better than being permanently stuck in the off position. And ultimately, for markets—where less bad is often good—this is what may matter most.
The impact of global containment measures
As of mid-April, daily COVID cases in Europe, Canada and the United States are plateauing. Containment measures appear to be slowing the spread of the disease and making this terrible burden a bit more manageable for health systems. But it also shouldn’t be that surprising as, for example, all of the provinces and territories in Canada have declared a public health emergency and ordered residents to stay at home as much as possible. In the United States, 95% of the population has been told to stay at home. And it is precisely because of these restrictions that the economic consequences have been devastating.
Unemployment rate soars
Last week, Statistics Canada reported that more than one million Canadians lost their jobs in March, and the unemployment rate has risen to 7.8%, a 2.2 percentage point increase since February.1
Meanwhile, data from the U.S. Department of Labor showed ANOTHER 6.6 million Americans filed for unemployment benefits, which, coupled with losses in prior weeks, we believe suggests the unemployment rate may now be around 15%.2 The good news? We already knew the data was going to be ugly in April—and the policy support keeps rolling in.
More help from central banks
Last Thursday, the U.S. Federal Reserve (the Fed) announced more programs that collectively could add USD $2.3 trillion of support to the U.S. economy. I won’t bore you with the details, but there are two particularly noteworthy considerations for investors.
First, the Fed isn’t done. They still have roughly USD $300 billion of Treasury capital remaining from the CARES act that they can lever up to provide another USD $3 trillion of support (plus or minus a nickel). Second, they’ve expanded their corporate bond program beyond investment grade securities, now allowing them to buy high yield bond ETFs and fallen angels.3 For some context on the latter provision, the cost of insuring against a default on Ford Motor Company, one of the largest U.S. fallen angels, was cut in half around the announcement late last week.4
Canada's central bank has been an active participant in the funding markets to ensure liquidity and access to capital. Moreover, the Bank of Canada has committed to purchasing a minimum of $5 billion of Canada bonds on a weekly basis until the recovery is well under way. Since the start of this crisis, Bank of Canada’s balance sheet has increased roughly $150 billion5, that is dramatically larger than following the global financial crisis.
Strong policy support across the globe
The shift toward policy support continues to be a global phenomenon. The most significant among these last week came from Japan, which approved a USD $1 trillion stimulus package, equivalent to almost 20% of GDP (gross domestic product).6
Markets are forward-looking and have focused more on the improved virus trajectory and substantial policy support than the bad economic data. We’ll have to wait and see if that trend carries through the U.S. earnings season. The MSCI All Country World Index has rallied about 20% since the close on March 23. Or, if you prefer your glass half empty, we estimate that we've recovered about 40% of the peak-to-trough decline in global equities.
Will the market rally continue?
If developed market economies are able to gradually reopen in the second quarter (and stay that way) markets should continue to rally. However, if that reopening causes another major wave of outbreaks—similar to the Spanish flu in 1918, which hit in multiple waves—a potential reinstatement of containment measures could have markets retesting their March lows. This is a known unknown that investors are forced to grapple with. On a 12-month horizon, we are positive, given cheaper starting valuations on global equities and credit, in addition to massive fiscal and monetary policy support. But, importantly, we believe upside and downside volatility are likely to remain elevated given the unpredictability of the virus.1 https://www150.statcan.gc.ca/n1/pub/14-20-0001/142000012018001-eng.htm
3 Fallen angels are companies that were rated investment grade (BBB+) before the outbreak but have subsequently seen their credit ratings fall to BB.
4 Based on pricing for a 5-year unsecured credit default swap. Source: Thomson Reuters Datastream. Fell from roughly 1400bp to roughly 700bp.
3 Fallen angels are companies that were rated investment grade (BBB+) before the outbreak but have subsequently seen their credit ratings fall to BB. 4 Based on pricing for a 5-year unsecured credit default swap. Source: Thomson Reuters Datastream. Fell from roughly 1400bp to roughly 700bp.5 Source: Bank of Canada