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  • KPB & Co Research

The Gist

It is a done deal. Regardless of the policy measures put in place by central banks and central governments around the world, the global recession, brought on by the spread of COVID-19, is certain to stretch beyond a quarter.  Most investors, businesses, and economists are more focused on whether sluggish economic growth will persist in 2021 and 2022. Certainly, a significant part of the stock market is positioning for a quick turn around given the bounce seen in the major Indices thus far. Looking at the IMF's recently published global economic outlook, it appears that the IMF favours a turnaround sometime after 2021, and this estimate could be revised later.

IMF Projections

In the IMF's revised report on its global economic outlook, they posited that global growth is now expected to be about -4.9% in 2020 and 5.4% in 2021. The revised expectation for growth in 2020 is 1.9 percentage points below that provided in April of this year. The institution also noted that there is significant uncertainty around its latest projection in light of the unprecedented number of unknowns that they had to accommodate when comprising their estimates this time. Perhaps even more telling is IMF's view that even with a growth of 5.4% in 2021, the amount of Gross Domestic Product would still be about 6½ percentage points lower than it otherwise would have been. According to the IMF, the baseline assumptions underpinning these forecasts are:

In economies with declining infection rates, the slower recovery path in the updated forecast reflects persistent social distancing into the second half of 2020; greater scarring (damage to supply potential) from the larger-than-anticipated hit to activity during the lockdown in the first and second quarters of 2020; and a hit to productivity as surviving businesses ramp up necessary workplace safety and hygiene practices. For economies struggling to control infection rates, a lengthier lockdown will inflict an additional toll on activity.

The IMF's economic outlook also shows that there appears to be a disproportionate impact on developed economies versus emerging economies, with developed countries expected to face a much harder hit in 2020 than developing countries will. In the Euro Region, in particular, growth is expected to decline by about 10.2% while Emerging Markets and Developing Countries as a group are expected to decline by 3.0%.  

IMF World Economic Outlook - June 2020
International Monetary Fund

Other Considerations

One of the key issues that the IMF pointed out, is the unprecedented uncertainty around their projections for the years ahead. In our view, there is a high probability that two of the key baseline assumptions may change as the months unfolds: that of declining infection rates, and the recovery of productivity. There is no question that the world economy will recover and move forward as it has always done. In the past, the world economy withstood the dual negative shocks of the Spanish Flu - which infected mostly people of working age and World War 1 (WW1) - which had its own impact on economic activity but was also a major catalyst for the spread of the virus. The real issue is when a full recovery will take place and IMF's projections suggest that full recovery may happen sometime in 2022. 

If infection rates increase beyond that anticipated in IMF's models, the recovery process may stretch out longer than anticipated. Some developed economies and China have seen declining infection rates as a result of the pause on economic activity. On the other hand, some municipalities within these countries have seen the virus gradually re-emerge as their economies re-open. China for example had to lock down parts of Beijing as the city faced a second wave of infections. In the USA, parts of Florida and Texas had to go back into lock down mode as the number of inflections sky-rocketed. This indicates the possibility that the ease in lock down measures may be too aggressive and a much more cautious approach is needed to keep the virus in check. A more cautious approach invariably means economic activity has to remain slow for a longer period or until a vaccine is developed and distributed throughout the population. There are indications that human trials are already being done, but a full-scale immunization of the population is still over a year away. Keep in mind also that some of the countries with municipalities that are going back into lock down were ahead in the re-opening process. Some countries in parts of Europe are in the very early phase of re-opening. 

The issue of productivity is a major concern. It is quite likely that productivity may remain depressed for a long period as manufacturing and service industries adapt to the new norm. Reductions in the spread of the virus in the absence of a vaccine go hand-in-hand with a reduction in population density in various public spaces. As a result, businesses in some industries will likely find it difficult to generate the revenues needed to cover their pre-COVID-19 costs even as economies re-open. In this context, major structural changes would have to be made such as reductions to the workforce or divestment of capital equipment. Take for instance Airlines, many airlines cannot survive if they are not able to sell tickets for the middle seat, at the same time there might be new regulations that prevent the sale of tickets for the middle seat as a means to combat the spread of the virus. Manufacturing companies, which rely on a certain layout of workers across a factory floor, will be forced to use fewer workers per shift if a restriction on people being at least 2 or 3 meters apart continues. These companies would have to fire employees or purchase another building, and given the reductions to demand it is more likely that workers will be fired. 

Final remarks

The point that stands out the most is the fact that today, there is a greater level of uncertainty about what the future holds than ever before. With unemployment rates in developed countries hitting double digits and GDP growth declining by as much as 30% in one quarter in some countries, many economists have argued that an analogous period would be the great depression of the 1930s. The stock market on the other hand appears to be quite optimistic. In view of these issues, it is very important that businesses and investors remain cautious but with an eye out for opportunities as things unfold.

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