Sydney-based Hamish Douglass of Magellan believes that the extent of government support to businesses will determine the speed of economic recovery from the coronavirus.
The manager of the £7.9 billion St. James’s Place International Equity fund assesses the economic impact of the COVID-19 pandemic and explains how he is positioning his portfolio.
What are your current thoughts on the coronavirus situation?
Modern market history provides no meaningful reference points for the current crisis. The scale of the potential economic damage is bigger than anything else we’ve seen. And, therefore, market behaviour, both during the crisis and in the recovery, could be very different too.
How do you assess the impact of the crisis on the global economy?
We are spending a lot of time trying to understand two fundamental issues:
1) How much economic activity is being lost while economies are in lockdown?
2) How effective will the policy response be in mitigating this output gap?
It is clear that the output gap here is going to be significant and much worse than in a normal cyclical recession. The longer the economic lockdowns last, the bigger the output gap becomes. Governments have responded in different ways to the crisis, ranging from hard suppression (e.g. China) through to softer guidance towards social distancing (e.g. Sweden).
Most nations, including the UK and US, are somewhere in the middle of this spectrum and we expect the total absence of demand here to last between two and six months, followed by a gradual recovery where the desire to normalise is balanced against the risk of further outbreaks.
This period of absent demand could be shortened if we see some form of effective therapeutic to the coronavirus emerging quickly. There is a significant global effort to reduce bureaucracy here and fast-track the process of development, but even in a best-case scenario, a therapeutic is unlikely to emerge in the next six months. This is not early enough to spare us from substantial economic damage.
How effective will the policy stimulus be in offsetting this economic pain?
We have been very impressed by the major central banks, which have moved swiftly and nimbly in this crisis. We have seen massive injections of liquidity into the financial system and an enormous scaling up of quantitative easing. There are some gaps in this support, however, and refinancing of lower quality corporate debt is likely to remain challenging, with huge potential implications for the financial system. The banks are generally in a much stronger position now than they were in the financial crisis, but we still need to be mindful of the risk of debt defaults.
What else are policymakers doing?
The extent of support is likely to determine the ultimate shape of the economic recovery. Most countries are adopting a strategy which directly compensates individuals for their loss of income, but not businesses. This is likely to head off an economic depression, but it will not enable a swift recovery. We are likely to see a deep and prolonged recession, followed by a gradual economic recovery in which unemployment remains elevated for a long time.
The next level of support is one in which businesses are compensated for part of their revenue loss. Here, a larger part of the output gap can be transferred to governments, with the remainder being borne by society. Ultimately, this level of support should enable a U-shaped economic recovery with more rapidity.