It’s not coronavirus so much, it’s how long?
We are clearly beyond the stage where the coronavirus is some minor league oddity like SARS or MERS, it is well on the way to being pandemic. In fact, the WHO has just declared that it is so, it’s pandemic. At which point, we as investors – rather than potential sufferers from it or those just interested in the human condition – need to know how long this is going to last. That’s the most important economic point.
Disruption, yes, that will obviously happen. But for how long will it do so? Are we to have some short period where GDP falls but then it recovers? Or are events going to continue long enough to significantly affect future GDP? Sure, this sounds rather bloodless, but it is the investors’ question. Stock prices are the net present value of all future income from that stock. A few month blip means one thing for such prices – permanently smaller GDP and thus profits another.
My view has been that it will be a short blip, however sharp that might be. Thus, the current stock market selloffs are an overreaction and, for us, become the opportunity to buy into good stocks at better dividend yields. Sure, profits might fall in this short term, but corporations do like to maintain dividends which is what interests us on this metric.
Morningstar and IHS Markit have both released analyses, which make much the same point. Long-term economic damage is going to be somewhere between small and trivial. The gap between now and then might be a little more exciting, though.
The IHS Markit analysis has as its lede the following:
IHS Markit estimates that global growth in 2020 will be 1.7%, compared with 2.5% in our February baseline, and 2.7% in 2021 compared with the earlier forecast of 2.8%.
While the US economy will be hurt by the effects of the virus, we believe that the momentum of the economy is strong enough to avoid a recession. On a calendar-year basis, we are now predicting 1.8% growth in both 2020 and 2021, compared with the previous forecast of 2.1% in 2020 and 2.0% in 2021.
As I’ve pointed out before, less than 3% global growth is our rule of thumb for a global recession. Simply because those less developed countries just should be growing nice and fast – the rich countries have shown them how it is done after all. So, yes, we can expect a global recession.
Yet they’re not expecting it to last particularly, the coronavirus effect. And in the US, they don’t even think it will reach a recession. Again, this is consistent with what I’ve been saying, that disease isn’t all that large an economic matter.
We also get another point that I’ve been keen on. The effects in Europe are likely to greater. No, not because the pandemic will be, rather, the economic situation in the eurozone is already much weaker. And the intuition is also as I’ve been saying. When the underlying economy is fundamentally strong, then a blip will be taken in stride, and we’ll be back to decent growth once it has passed. But if we’ve got fundamental weakness already – and no room for monetary policy – then that blip will be the trigger for worse effects.
The Morningstar is wider in its analysis. And while the numbers are different – as they should be, otherwise we’d suspect they’re just reading each other and copying – the underlying story is the same.
Overall, we see a weighted average hit of 1.5% to 2020 global GDP and 0.2% to long-run global GDP. We forecast a muted long-term impact because damage to productive capacity will be small. Plus, economic confidence should quickly return once the virus subsides.
(Please note, both sources are email sources, so online links are not available)
Here’s their economic forecast for the world:
(GDP forecast for coronavirus from Morningstar)
Note that, even in that worst case, the GDP effect is of missing out on a couple of months of global growth, no worse than that. This being something I’ve been saying independently, disease just doesn’t have that much effect on the economy. Oh, sure, 5% looks like an awful hit, but that’s short term. Stock prices are determined by that long, not the short.
They spend much of their report talking about treatments, infection rates, and so on. We as investors are rather more interested in this:
Economic Impact: We Forecast Minimal Long-Term Effect on GDP From Coronavirus
Although we project a grim set of scenarios in terms of fatalities in our analysis, our view on the economic impact is much more sanguine. Weighting our scenarios by probability, we forecast an average negative 0.2% long-term impact on World GDP due to the COVID-19 pandemic. To be sure, we expect a much larger impact in the short run (with an average negative 1.5% impact on 2020 World GDP across our scenarios). However, equity valuations on average should be unscathed if our long-term projections on GDP are correct. Therefore, we think a 10%+ fall in global equities since the outbreak began is a gross overreaction.
As I’ve been saying, equity valuations depend upon that medium to long term, and a rebound in the economy means there shouldn’t be quite as much effect as there has been. This is thus – at the local bottoms – a buying opportunity.
Economic studies of pandemics
I’ve linked to this before, and it’s worth doing so again. I disagree with the author on most things but accept his ability as a macroeconomist:
But even with all schools closed for 3 months and many people avoiding work when they were not sick, the largest impact we got for GDP loss over a year was less than 5%. That is a one quarter very severe recession, but there is no reason why the economy cannot bounce back to full strength once the pandemic is over. Unlike a normal recession, information on the cause of the output loss, and therefore when it should end, is clear.
We keep coming back, in all these analyses, to the point that even if the disease is horrible, the economic effects are short term, and even if they are bad in that short term, in the long, we’ll scarcely note that it all happened. And, again, stock prices are based – or should be at least- upon that medium to long term.
All of this is true only of economies which are fundamentally strong. And of stock markets which are accurately reflecting that underlying economy. Which I’m not convinced holds for everyone at present.
The UK and US stock markets have recently been on something of a tear. A 5 or 10% correction wouldn’t have been out of place – just for reasons of sentiment – for either of them. Which is where I’d start my measurement of 10% further being too much from.
The eurozone is very different. It’s stuck in a slow to no growth paradigm. Sure, I think it’s the euro itself, which is the problem but let’s leave that aside. The currency area clearly has problems which the varied Anglo-Saxon economies simply don’t. Given the paucity of policy space, I expect the eurozone recovery to be much worse than the bounceback I expect for the US and UK.
I am thus a little different from the Morningstar and IHS Markit view, even as I agree with the fundamentals of it. The effects of the coronavirus might well be sharp, but they’re going to be short. Looking back from 10 years in the future, we’ll not be able to see the permanent loss of GDP nor of stock prices. Thus, significant stock losses now are an over-reaction.
However, I’m willing to think that the UK and US markets could have lost perhaps up to 10% of froth anyway. I’m thus arguing that a 20% loss is too, too much. As for the eurozone markets, I think those economies have underlying problems which are simply being revealed here, and I’d not argue that they are good investments at any likely price.
Of course, I could be wrong. This might be the Black Death all over again, where capital fell significantly in value and labour rose. But I don’t think so.
The investor view
The end result of all of this, from Morningstar, IHS and myself – for whatever value you put on the three variously – is that, as investors, we should be looking beyond the immediate effects of the coronavirus and to the long-term ones. Those being that, if the markets panic and skip, then there are some bargains for us.
I’ve mentioned here before Shell (NYSE:RDS.A) – a 9% dividend yield is an excellent long-term lock in. There will be such bargains. They’ll not be among the high risk stocks as the price of risk always rises amidst uncertainty. It’ll be the old, boring, and dividend paying stocks that the bargains for the core portfolio will be found.
For the UK and US markets more than 20% off recent peaks is a buying opportunity for these now decently yielding stocks.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.