Feature Stories | Nov 16 2020
Eight months down the track we have a second wave, a vaccine hopeful, changing attitudes in society and massive fiscal support, which may lead to the “zombification” of economies.
-Business confidence on the wane again
-V-shaped recovery at risk
-Shifting electoral attitudes
-Propping up the otherwise dead
By Greg Peel
News of a vaccine candidate proving 90% effective has spun world markets on their heads. Yet it had been predicted earlier in the year, at least by many, that we would have a vaccine by the end of this year, if not earlier.
Arguably, global markets, particularly in the US, had already to some extent priced in this assumption. But while faith was not lost, along came the global second wave.
Prior to the second wave ultimately proving worse than the first, economies around the globe had experienced a notable V-shaped (if not Nike swoosh-shaped) economic recovery in the September quarter, and assumptions remained positive for the December quarter, if not quite so dramatic. But the second wave has killed off that sentiment.
In the US, it had been hoped that before the initial round of government fiscal stimulus expired, a second round would be agreed upon by Congress. It wasn’t. Then as the second wave took hold across the country it was assumed Congress will agree on a package for the simple reason that it must.
Not to be. Indeed, still not to be, and unlikely before Biden’s inauguration and, if the Republicans retain the Senate, a stalemate may yet drag on. But…and it’s a big but…if there’s a vaccine, will a second package be needed?
One might argue no, but by that time more small businesses will have gone under, more tenants will have been evicted, more home owners will have been foreclosed upon, and unemployment will likely start rising again. And it still may be months before a vaccine can be widely distributed.
If markets do look ahead to successful widespread distribution, will they price in “back to normal”? Back to a pre-covid world?
No, is the consensus — a post-covid world will look different to a pre-covid world, and we still have to get there.
FNArena first examined what a post-covid world might look like in a three part series Life After Covid, published in June-July (links below). At that stage predictions were heavily speculative.
Last month FNArena published Australian Retail: Whereto From Here (link below), which drew upon the actual trends evident in the ensuing period underpinning or dismissing, at least in the retail sector, earlier speculation.
This series picks up where the first three parts left off, looking at the wider picture, eight months along from the initial March lockdowns, drawing upon research and analysis informed again by noted trends in the period. What will a post-covid world look like? And what is yet to transpire, as the second wave grows ever more virulent, before we even get there?
Note that research drawn upon for this article was published both before Pfizer’s vaccine announcement and before the US presidential election was run and, it appears, won, but with a vaccine still anticipated sooner rather than later and a Biden victory at that stage looking the most likely.
No escaping the gloom
Oxford Economics early this month published a survey of large businesses across the globe, addressing business sentiment. Oxford previously conducted a “flash” survey in September.
The survey was conducted in October, at which time positive signs had appeared in economic data but the global second wave case-count was now running out of control. Suffice to say, sentiment had again begun to wane.
Businesses last month saw risks as more weighted to the downside. Over half (51%) saw risk “slightly” weighted to the downside but 11% saw risk “heavily weighted” to the downside, up from 7% in September. 90% assumed economic growth will be net negative for the year 2020 by an average -3.6%. The average expectation for 2021 is 3.3% growth.
66% judged a return to nationwide lockdowns as a top three risk. This is already playing out in much of Europe and the UK, but not the US, yet. 12% cited inadequate US fiscal stimulus as a top risk and 28% cited trade policy as a top risk.
The greatest risk (39%) was perceived to be climate change, although almost a third suggested the risk was not significant.
91% of respondents agreed the risk of structural weakness and levels of indebtedness due to the pandemic are a significant risk. 82% agree the risk of repeated waves of the pandemic is significant.
As to the shape of an economic recovery, only 7% of Oxford Economics’ survey respondents still see a V-shape. 20% see a U (gradual turnaround), 16% a W (second wave impact) and 10% an L (growth remains subdued). 40% back a square root sign – an initial V flattening out to a period of subdued growth.
Oxford Economics suggests the global recovery from the June quarter recession remains intact but is patchy across economies, and may now be faltering in some as re-lockdowns are implemented. It is also uneven in sectors, with services remaining the big problem area (travel, transport hospitality…).
Retail spending rebounded strongly into the September quarter, including in China, the US and UK [and Australia], but that may now be giving way (UK re-lockdown, US rising case-count). Europe faces the risk of a double-dip as services indicators have gone back into contraction and mobility indicators (which Google tracks) have flattened off.
World goods trade rebounded by an impressive 10% or so in the September quarter but again, unevenly across economies and industries. Service trade remains depressed and Oxford Economics is expecting a -20% decline in 2020. The US and eurozone both posted record-breaking GDP increases in the September quarter as economies re-emerged from lockdown, but there were clear signs of slowing even before re-lockdowns across Europe and the UK began.
Oxford Economics does not expect the second round of lockdowns to be as economically debilitating as the first, and come at a time other key regions continue to expand, but contractions of as much as -3% appear likely across major European economies in the December quarter.
The first round of lockdowns was more panicked – no one knew what might transpire – hence everything was locked down beyond essential services. This time around, as the economists note, experience in the interim has allowed lockdowns to be more measured. In France, for example, this time around schools, factories and construction sites will remain open. Closing schools means forcing at least one parent to remain at home, unable to work.
But while this might be a positive, on the negative side lays the hit to sentiment. Even in the first panicked lockdowns it was assumed the crisis would not last beyond one quarter – two at the most — and by 2021 all would be back to normal. Now that re-lockdowns have begun, households and businesses will likely be more wary. Major purchases and investment/hiring plans that were delayed this year could be permanently shelved, Oxford warns, pushing the focus back to belt-tightening and cost-cutting.
And as has been noted by many an Australian stock analyst since the August result season, and more recently the quarterly update season, Oxford warns many purchases made during the first lockdowns, such as office furniture, electronic equipment and gym equipment (and we could add in household furnishings among other things), won’t be repeated.
Another negative issue Oxford points to, which again is evidenced in Australia, is after having gone in hard on fiscal support during the first lockdowns, economies that are now heavily indebted won’t be keen to go so hard again. Witness the trimming back of JobKeeper in Australia and the announced trimming back of JobSeeker next year. And witness the US Congress’ inability to agree on a second package.
There is, of course, one thing that could render all of the above moot – a vaccine. But even if there is a vaccine (and remember, research cited so far pre-dates the Pfizer announcement), Longview Economics suggests further stimulus is not needed anyway. At least in the US.
There has been much heartache over the US Congress’ failure to reach a stimulus agreement. Longview believes the heartache has been unnecessary. Drawing upon the most recent data, Longview notes US households have amassed more than US$1trn of savings since the pandemic began. Add in corporate savings and that figure rises to US$3.3trn.
The whole point of fiscal support at the time was to prop up household budgets so they could still keep spending, thus helping to prop up businesses and jobs. But while increased spending has been evident as noted earlier, savings rates suggest not to the extent a government would hope. Similar patterns have been evident in Australia, more notably in using government support to pay down debt.
So, says Longview, the US does not need further fiscal stimulus. What it needs is a vaccine. A vaccine would release the full effects of that earlier stimulus that has been held on to out of caution and likely result in a rapid fall/normalisation of household savings levels, thus driving robust economic growth.
One issue to contend with in this theory, notwithstanding the time it will take to get a vaccine out to the global masses and subsequent business failures and job losses in the interim, is that it assumes widespread acceptance of said vaccine. Surveys in the US suggest as much of half the population say they will not be vaccinated – not because they are staunch anti-vaxxers or covid-deniers but because they fear the approval process has moved just too fast for safety to be guaranteed.
“Operation Warp Speed”. What’s in a name?
We all learned early on this year that the vaccines of the past took years to develop, not months, and that a vaccine for covid’s predecessor SARS has never been found. Note medical types often refer to covid as SARS cov2.
This hesitation suggests even a vaccine, or many vaccines, may not be an immediate sentiment swinger but rather many will wait to be sure of a vaccine’s true efficacy and lack of side-effects.
Break on through to the other side
Assuming a vaccine does prove sufficiently efficacious, be it Pfizer’s, or another, or many, we can return to the central thesis of this series: how will the world change in the wake of the pandemic?
Kim Catechis of the Martin Currie Long-Term Investment Institute points out the world was already notably changing before the pandemic hit. Trends already evident in society, the global economy and geopolitics will accelerate post-covid, but not deviate substantially.
The course had already broadly been set, notes Catechis, from a growing rejection of traditional politics, to an increasing focus on climate change and a technology-led reinterpretation of business models. In the latter case we can cite the so-called “disrupters” which had already begun to upend traditional business models through technological advancement, and most specifically “the cloud”, and even the simple growth of online business.
Covid will nevertheless lead to a change in the role of the state even in “mature” and “stable” governments, Catechis contends. The harsh reality is “big government” is better placed to deal with a pandemic, and even governments hitherto considered mature and stable democracies have been forced to stretch traditional norms this year.
An interesting case in point is Australia, I might note. Early in the year the hastily created National Cabinet was much lauded by all, such that suggestions were made it should be a permanent fixture. Back then, you may recall, we were “all in this together”.
When the second wave hit and state borders were snapped shut, the mood changed. Victoria’s second lockdown was much derided both inside and outside the state, including by the prime minister and federal treasurer. The Queensland premier was loved internally but hated externally. The WA government had to fight off a law suit. We were no longer in this together.
In the US, the president refused to acknowledge the virus as any sort of threat. States determined initial lockdowns, and then re-openings were quickly implemented, mostly along party lines, leading to the second wave. Even as the second wave becomes a tsunami, federal government is atrophied.
The covid experience will lead societies to reassess priorities and change attitudes to economic systems, suggests Catechis, at least for a generation. The manner in which governments behave over the next couple of years will set the direction for the next generation. One component is the treatment of risk and the cost of doing nothing about it. Another is an increasing rejection of government and of globalisation. Society will continue to focus on inequality and nationalism and these themes will drive policymakers in many countries.
The global extent of the cost of covid, both in lives and livelihoods, could result in a recalibration of attitudes to global threats. Intensifying public pressure could result in a higher prioritisation of climate change policy, says Catechis. Given his paper, entitled The Aftermath – the world after covid-19, was published in October we can assume his research pre-dated recent announcements of emission reduction targets in China, Japan, South Korea and the UK, and by the US president elect.
Geopolitical risk will increase, says Catechis. US versus China has laid the foundation.
Every dormant or low-intensity geopolitical stress-point will now become more amplified. The failure for the two strongest players to reach an accommodation means everyone will feel free to ratchet up their own priority list. For many countries there are sources of geopolitical or even existential risk that have lain dormant for over 70 years and are re-awakening now.
Witness Armenia and Azerbaijan. Note also Biden’s policy towards China does not differ from Trump’s, just the manner in which he will approach it.
Fear the Living Dead
The level of global fiscal response to the pandemic has made the GFC look like a minor distraction. The Economist Intelligence Unit, related to The Economist magazine, notes G20 countries to date have announced fiscal packages worth US$11trn, roughly the amount of the Japanese, German and French economies combined.
Public debt to GDP ratios will rise to around 140% of GDP across developed economies, the equivalent of US$13,000 per head. Rudd handed out $900 in 2009, and not to everyone.
In the past, such a level of debt would lead economists to ponder which country would be the first to experience a sovereign debt crisis. But not this time, the EIU notes.
Firstly, already groaning with debt, governments have turned to central banks to finance their spending. Instead of sticking to their mandated role of controlling monetary policy, central banks have been tasked with enabling governments to roll out massive stimulus packages. In March-April, the US Federal Reserve purchased more government debt than the entire 2019 US budget deficit. The Fed also now holds more than 11% of US corporate debt, giving the central bank an unprecedented sway, the EIU suggests, over corporate America.
Secondly, low inflation means sovereign debt will actually erode over time. One former IMF economist has noted that at zero interest rates, “it doesn’t matter whether you finance by money or by debt”.
The fear nevertheless, as central banks drove rates to zero, was that supply chain disruptions caused by the pandemic would lead to shortages of goods and subsequent price-spikes. But this has not been the case. With consumers choosing to save rather than spend, and businesses postponing investment spending, inflation has been kept in check.
The attitude of governments in March was to act now and worry about the consequences later. But those consequences will eventually need to be tackled down the track. One thing is for sure, the EIU offers, is that austerity will not be an option.
It didn’t work for Europe in the GFC-driven debt crisis.
Throwing austerity demands at an already shattered population would not rate well with focus groups, particularly when governments are under close electoral scrutiny with regard their handling of the pandemic. And the pandemic has only served to highlight, the EIU suggests, the fallout of years of underinvestment in public services such as healthcare.
Tax increases would also not go down well, and would not go anywhere near far enough to offset the debt increases, the EIU notes. Note Biden plans to reverse Trump’s tax cuts, but will likely not do so in his first year and would offset with a significant stimulus package, ie more debt. In Australia, taxes have been cut.
Sovereign debt defaults? In any crisis investors rush to the “safety” of US and Japanese bonds, despite both countries, before the pandemic, already carrying debt that could never be repaid. Weak economies like those of Italy and Spain may be vulnerable, but the ECB would never let that happen.
Advanced economies may thus find, the EIU notes, that when it comes to managing their debt they need to do precisely nothing.
And that means an opportunity is created to finance investment and research to fuel a post-covid recovery and boost long term growth prospects. This is not without risk, the EIU warns. When governments handed out what we here call JobKeeper/Seeker and provided loans to businesses, they didn’t discriminate. They did not make a judgement about which businesses would be temporarily impacted and which would not survive.
This will lead to a rise in the number of “zombie” companies, the EIU suggest – companies that will spend years paying off their debts to the government rather than investing in R&D.
The greatest risk is that inflation will eventually rise as economies recover, leading to central banks increasing rates and sending businesses to the wall. But the post-GFC experience suggests this is not the case. Excess liquidity created by central banks did not result in price/wage inflation, just asset price inflation (stocks, bonds, property).
The Japanese experience is one of inflation remaining stubbornly low ever since the stock/property market crashes of 1989, no matter what monetary and fiscal measures were thrown at the economy. Japan gave us the “zombie banks” – banks loaded with non-performing loans that the government would not let go under for fear of economic catastrophe.
“Coupled with a bleak demographic outlook, these three characteristics—slow growth, low inflation and high debt— will become common features of advanced economies in the coming decades. The impact of such unprecedented conditions will be a game changer for the global economy. The pandemic may not last once a vaccine is found. However, the post-coronavirus zombification of advanced economies appears to be here to stay.” – EIU.
Life After Covid Part V coming soon.
Life After Covid Part I (https://www.fnarena.com/index.php/2020/06/02/life-after-covid-part-i/)
Life After Covid Part II (https://www.fnarena.com/index.php/2020/06/10/life-after-covid-part-ii/)
Life After Covid Part III (https://www.fnarena.com/index.php/2020/07/10/life-after-covid-part-iii/)
Australian Retail: Whereto From Here (https://www.fnarena.com/index.php/2020/10/13/australian-retail-whereto-from-here/)
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