When analysing the impact of the Covid-19 pandemic on the stock market, by far the most significant bear case to worry about logically follows from the widely reported and influential recent Imperial College study of the virus.
The team at Imperial believes we may need to keep applying severe social distancing measures until a vaccine becomes available because the virus is likely to bounce back whenever we lift the restrictions again. The problem is that a vaccine is perhaps 18 months away so this could cause a depression.
Right now, demand is collapsing across much of the global economy because it must. It is inhumane not to shut down the economy to suppress the virus. The immediate job for economic policy is an unusual one: rather than stimulate a recovery now, it must build a bridge to a recovery once the threat of the virus has been removed.
As such, evaluating the economy as it pertains to the stock market is a bit different this time around compared with previous recessions. The bridge needs to be built well and hopefully will not be required to span too great a distance.
As ever, it is essential to the bull case that central banks fulfil their key role of lender of last resort to financial markets under extraordinary stress. Encouragingly, they are moving through the gears extremely quickly, benefiting from the experience gained and tools built during the Global Financial Crisis (GFC) in 2008/09. They have more to do but appear up to the challenge.
Fiscal policies have rightly focused on helping businesses and households maintain critical levels of cash flow and incentivising businesses to keep employees in jobs where possible. In this way, the government can hopefully preserve the supply capacity of the economy until the demand recovery is possible.
While dramatic, as long as the recovery is not too distant, this appears doable. Say the level of GDP were to fall a huge 30% during social distancing, then fully supporting cash flows would cost the government about 2.5% of annual GDP per month.
This would obviously be an unthinkable burn rate in normal times but would coincide now with substantial QE programmes and would compare with an overall rise in G7 countries’ average government debt to GDP ratios of 33% due to the GFC.
However, it is my strongly held view that the absolutely pivotal policy measure upon which the bull case for stocks rests lies in breaking the bleak logic of the Imperial study. Put simply, the mass scaling up of production of virus tests and personal protective equipment (PPE) for everyone – the whole population – over the coming weeks can prevent a depression. This might seem banal by comparison with the development of the vaccine that will hopefully ultimately eradicate the virus or even monetary and fiscal fireworks. But the other key to a successful and timely recovery is building a basic infrastructure for an economy that can live with Covid-19 until the vaccine arrives, whilst running at a good level of activity, successfully suppressing the virus and protecting the vulnerable.
Close to daily home testing of almost everyone who hasn’t had the virus will enable the rapid identification of local outbreaks. These can then be combated efficiently by contact tracing and rapid localised social distancing measures.
Technology can help with this approach in the form of smart phone apps that enable live mapping of the virus, which is already being used in some Asian countries. Pervasive antibody testing will tell us everyone who has had the virus and who is thus now at much lower risk, at least temporarily.
PPE for everyone will feel a bit unusual at first but will help to reduce transmission sufficiently to give people the confidence to go back to work. It will help protect the vulnerable and enable others to look after them without harming the vulnerable.
To achieve all this, the degree of scaling up required resembles past wartime efforts to reorient swathes of production facilities towards delivering supplies. This will not be possible without governments’ orchestration and commitment to purchasing the enormous quantities needed. With social distancing and macroeconomic support policies in place, it is the policy we need to see next.
If this does happen, today’s stock valuations, sitting at around the 10th to 20th percentiles across major developed markets, are attractive. If not, it is worth noting that valuations are still some significant way above the trough of 2009 and the outlook could be worse than then.
Preventing the bear case is absolutely not beyond our capacity.
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