Economics & Markets

Coronavirus: the case for optimism and reasons for caution

By Michael Gray
Head of Investments NZ New Zealand

In my post last week I talked about perceptions of risk – the psychology of sounding positive and the tendency to focus on what can go wrong. Following on from this, I look at the impact of Coronavirus on global economic activity and share market performance from both a positive and more cautious perspective. Here is a summary of the reasons to remain cautiously optimistic while also being conscious of the global risks.

The case for being positive

1. Economic impacts less severe.

With each wave of the virus the economic impacts have been less severe. This is evident with the latest more contagious Delta variant of the virus and reflects a number of factors:

  • More people in the world are vaccinated as each month passes. Currently 51% of people in the developed world have had two doses of a vaccine, this number is 27% in developing nations and 20% in New Zealand.
Source: ourworldindata.org, AMP Capital
Source: ourworldindata.org, AMP Capital
Source: ourworldindata.org, AMP Capital
Source: ourworldindata.org, AMP Capital
  • The vaccines appear to be effective from the perspective of reducing the severity of illness and hospitalisation rates. This is evident in the highly vaccinated countries of the UK, Canada and across Europe (see chart below). 
Source: ourworldindata.org, AMP Capital
Source: ourworldindata.org, AMP Capital

A comparison between low and high vaccinated states in America also sees contrasting results. The lowest 25% of US states by vaccination are seeing three times the number of new cases per capita, four times the number of hospitalisations and seven times the number of deaths compared to the top quartile of states by vaccination.

  • After each lockdown economies have bounced back strongly, reflecting pent up demand and accommodative policy settings by governments and central banks. This in part reflects that government spending initiatives have helped protect businesses, household incomes and jobs while lockdown measures have been put in place.
  • Individuals and corporates have adapted their behaviours, eg working from home, social distancing norms, and businesses have found ways to operate at different levels of restrictions. This is harder under harsh lockdowns. Although lowly vaccinated countries have little choice for such measures, higher vaccinated countries can put in place less restrictive lockdown measures that have fewer negative impacts on economic activity to limit the spread of the virus.

Therefore, although global economic growth is expected slow because of increased covid cases, the global economic recovery is not expected to be derailed.

2. Government and central bank policies are expected to remain accommodative for some time.

  • Government spending globally will be supportive of economic activity over the next few years. Large government spending plans have been announced this year in America and Europe. Just recently, US President Biden’s $550 billion infrastructure package and $3.5 trillion budget resolution passed through the Senate and House of Representatives, money that will be spent over the next eight years.
  • Although some central banks around the world will likely begin tightening policy positions by reducing the pace at which they purchase securities and/or raise interest rates, central bank policy positions will not be ‘tight’ for some time. Among the developed countries, the Bank of England, Reserve Bank of New Zealand and Bank of Canada are further advanced in the tightening cycle, followed by the US Federal Reserve. The Bank of Japan, Reserve Bank of Australia and European Central Bank are some time away from increasing interest rates.

3. Corporate sector is in good shape

Recent corporate profit announcements in the US, UK and Europe have produced results much better than expected just months ago. The current corporate profit seasons in Australia and New Zealand are displaying similar characteristics. As a result, corporate balance sheets are in great shape, benefiting from a much better economic outcome than anticipated 12-18 months ago.

Accordingly, companies are increasing dividend payments and announcing share buyback schemes. In America, share buyback announcements have totalled $683 billion year to date, among the highest amount on record. In addition, particularly in the US, corporates are planning increasing levels of capital expenditure and investment. This is good for economic activity and future earnings.

4. Consumer confidence is also good

Although consumer confidence varies around the world, globally consumer confidence rose to near pre-pandemic levels earlier in the year (consumer confidence has fallen more recently given rising coronavirus cases). Consumers around the world are in good shape and it is estimated that globally consumers have amassed an extra $5.4 trillion of savings since the coronavirus pandemic started. This has resulted from government handouts that have not been spent and decreased spending from activity constraints.

Consumer confidence has rebounded due to the reduction in health risks given the roll out of vaccines, rising share markets and house price appreciation. Reductions in debt and lower interest rates have also eased household debt payment burdens.The Bank Credit Analyst (BCA) estimates that if US consumers spent half of their $2.3 trillion of excess savings by the end of 2022, that would amount to a tailwind equivalent to 5% of a year’s GDP and keep the US growing at well above trend in 2021 and 2022. 

Reasons for being cautious

1. Risks around the coronavirus

With the increasing number of people being vaccinated around the world the threat of the virus is reducing. However, the virus is a key risk to global economic activity and share market performance from two perspectives:

  • New Covid variants. As we have seen with the Delta strain, new variants of the virus will likely come along, the risk being that these new variants are highly contagious, vaccine resistant and more lethal than the original strain. Albeit the vaccines have been found to provide protection to the new strains and producers of the vaccine will be able to adjust their formulas to fight any strain that is resistant to current vaccines.
  • Vaccine hesitancy. Experience overseas is that countries rapidly move to 50-60% of their populations vaccinated and then the rate of increase in the population vaccinated slows. This still leaves a large proportion of the population unvaccinated and the risk to public health system remains elevated. Evidence of the effectiveness of the vaccines and government measures such as Covid-passports, that will be required to travel without the need to quarantine and to enter gyms, restaurants, entertainment centres and sporting arenas, are expected to reduce the level of vaccine hesitancy over time. The full approval of the Pfizer and BioNTech vaccine by the US regulator recently is also expected to help in reducing vaccine hesitancy in the US. Rising covid cases in a country has also seen an increase in those getting vaccinated.
Source: ourworldindata.org, AMP Capital
Source: ourworldindata.org, AMP Capital

2. No fire power left

Put simply, governments and central banks have very little left to fight a new crisis. Government debt levels are at elevated levels, central banks have bloated balance sheets from purchasing securities via their quantitative easing programmes and interest rates are at ultra-low levels. This leaves the global economy vulnerable and a potential reason to be cautious.

Source: ourworldindata.org, AMP Capital
Source: Bloomberg, AMP Capital

3. Consumer purchases brought forward

The consumer spending globally that has been undertaken over the last 12-18 months has dis-proportionally been on goods (eg DIY projects, household furnishings, boats) rather than services (eg eating out, accommodation, travel and entertainment).Therefore, as the economic recovery matures and countries continue to open there is the risk that spending on goods will slow, eg spending will move away from online spending and move more towards services. This remains a threat to retailers and manufactures, and potentially could result in a softening of economic activity.

4. Slowing global growth

The rate of global economic growth appears to be slowing, as seen in recent economic data in the US (July retail sales fell more than expected) and China (economic activity indicators for July such as retail sales and industrial production disappointed).Forward looking measures, the manufacturing and non-manufacturing (services) sector surveys, also appear to have peaked and are falling in the US, UK, Europe and Japan.  The service sector surveys have been particularly weak, reflecting the impact of lockdown measures around the world. Accordingly, economic growth estimates for the September quarter 2021 have been downgraded for the US and China.

Source: ourworldindata.org, AMP Capital
Source: Markit, AMP Capital

Nevertheless, these survey results generally remain robust, and although growth is slowing the rate of growth is expected to remain above trend for 2021 and into 2022. Further action by the Chinese administration to support their economy and the positive factors as outlined above remain supportive of global economic growth over the medium term.

5. A wall of worry

As always, there are several issuers simmering in the background. Currently providing some uncertainty is China’s regulatory crackdown and pursuit of common prosperity plan, current US debt ceiling will limit government spending initiatives, inflation remains higher than expected and ongoing political tensions between the US and China. Although reasons for concern, each issue is unlikely to have a material impact on global economic activity, but all are potential sources of market volatility.

At the same time, markets are entering a traditionally tough period as August ends and September and October fast approach. This occurs after a period of very strong performance from global share markets so far this year.

However, overall, we remain cautiously optimistic. Although conscious of the global risks, the tail winds of the positive influences presented above are likely to support global equity markets over the medium term. 

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Important notes

This blog post has been prepared to provide general information and does not constitute financial advice in accordance with the Financial Markets Conduct Act 2013. An individual investor should, before making any investment decisions, consider the information available in the relevant Product Disclosure Statement and seek professional advice. While every care has been taken in the preparation of this document, AMP Capital Investors (New Zealand) Limited and the AMP Group (together, 'AMP') make no guarantee that the information supplied is accurate, complete or timely and do not make any warranties or representations in respect of results gained from its use. The information is not intended to infer that current or past returns are indicative of future returns. The views expressed are those of the author and do not necessarily reflect those of AMP. These views are subject to change depending on market conditions and other factors.

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