WELCOME TO THE LATEST EDITION OF VANTAGE POINT
Since our last publication, the world has seen the emergence of a novel coronavirus that has infected large numbers of people in China and the rest of the world. Of course, this is first and foremost a human tragedy and, at the time of writing, it’s very difficult to judge how widely the disease will spread. That said, it is having and will continue to have a large economic impact and much of this edition is devoted to trying to work out what that might be. As regular readers will know, we don’t deal in point forecasts – and a shock like the emergence of the coronavirus highlights the strength of the scenario-based, probabilistic approach we take. By mapping plausible scenarios, probability-weighting them and generating summary fan charts for key asset prices, we can draw broad investment conclusions that we think take account of the full distribution of likely outcomes.
The coronavirus appears to be more infectious but less deadly than some other diseases, such as SARS or MERS. That means the main economic impact is likely to be felt through the measures taken to contain it – for instance, travel restrictions, reduced working time and, in extremis, quarantine. A number of countries have already gone into effective lockdown, including the US and much of Europe and this will have a dramatic impact on GDP in the first half of the year and possibly beyond. Already, a global recession in 2020 looks more likely than not.
In economic terms it is both a supply shock and a demand shock. It cuts supply because working hours fall and supply chains are disrupted; and it hits demand because people can’t go out shopping, buy services face-to-face, or go on holiday. Markets have reacted with shock – as of March 23 the S&P 500 is down 34% from peak – already the 5th largest post-war recessionary drop, in a fraction of the time it took the others to get there. Central banks fear the demand shock more and the Fed has led the way with rate cuts and a relaunch of QE. Financial market stresses have appeared and central banks have coordinated to supply the overwhelming demand for cash and dollars. Longer term, the situation could get more complicated should the substantial hit to global supply push up global costs and prices, especially if that impact endures because the spread of the disease causes de-globalization to accelerate.
Our scenarios explore these and other issues in depth. There are a couple of ‘upside’ V-shaped scenarios, but there are also two downside ‘U’ and ‘L’-shaped ones. In each case we go through the economic mechanisms in some detail and end up with some very distinctive economic and market outcomes. In the end though, this is a hugely uncertain situation and I encourage readers to use the scenarios to test their own assumptions, whether that’s ‘time to buy’ or ‘it’s Armageddon out there’, or anything in between. Our own broad investment conclusion, based on the return and risk expectations embodied in our fan charts, is that a more risk-averse stance may be prudent until we have more clarity. The potential for a strong bounce back exists no doubt but, it’s not clear from our analysis that the expected gain in the best scenario outweighs the expected losses in the worst.
As ever, we hope you enjoy reading the document and look forward to your feedback.
BNY Mellon Investment Management
What We Think - Economic Scenarios
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