In search of the bottom in the Covid-19 crisis

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Markets are leading the real economic cycle and therefore they will bottom before the end of the pandemic.

In this unprecedented time of high uncertainty from a sanitary and economic perspective, the different drivers at play are moving in different directions. These forces make the exercise of GDP forecasting quite tricky and not particularly helpful for the time being.

Markets are leading the real economic cycle and therefore they will bottom before the end of the pandemic. However, they will calm down and be reassured on the path forward when they can anchor expectations on three points:

  1. The cyclical pattern of the pandemic, or when there is some sign of an improvement on the speed of the contagion. This depends on the “time” variable (the extension of the crisis period) and on the mobilisation efforts (the containment measures put in force in the different states). Early containment with strong measures such the ones applied in China and most recently in the main Western countries could help limit the spread of the virus;
  2. The ‘whatever is necessary’ tactics of fiscal and monetary authorities, and whether or not monetary policies and fiscal measures are considered credible and effective to ease financial conditions for the corporate sector or to provide adequate resources to the household sector to face a period of higher unemployment due to the shutdown of economic activity;
  3. The short end of the credit curve, after recent dislocations, and core bonds yields, which have started to rise since the fiscal measures have been announced, discounting higher future debt.

We should acknowledge that we are in a situation similar to October 2008, when uncertainty was very high, volatility was extreme and liquidity was vanishing. The market bottomed in March of the following year. However, this time extraordinary measures have been put in place at an earlier stage of the crisis (2008 was a lesson) and the stimulus is significantly bigger. Markets will take time to digest all these measures, but will start pricing in that they are unlimited.

However, the policy bazookas will not be effective unless there is a corresponding fall in the speed of contagion. The combination of the two will drive the timing of the recovery and, as long as the pandemic does not seem to be under control, volatility will persist.

In our view, what matters most to investors is the speed (second derivative) of the pandemic’s direction. The direction is still pointing towards a rise in the number of cases, with an increasing speed in recent weeks. When the containment measures start working the speed should decelerate. This happened in China first and we now see some signs it is happening in Italy as well, which is helping to provide some relief to the market. However, normality will not come directly after the pandemic is contained as some sort of social distancing (resulting in a higher percentage of smart working, higher online consumption, more online entertainment and online education, higher social media usage, increased demand and salary for medical jobs, etc.) will remain in place as long as a vaccine has not been found. This, again, is the case in China, where activity is slowly resuming after the lockdown but still remains below normal levels.

Most countries are still some way away from their peak, with the UK and the US still in an acceleration phase, as well as many EU countries, while some EM countries are still at an early stage. If this global lockdown proves successful, the pandemic should accelerate towards its peak in the next month, after which the speed in the growth of new cases should start to diminish.

We are moving in this direction, but we are not there yet and in the short term we can only expect temporary relief from the extreme market dislocation rather than a full and stable recovery.

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