Fathom’s Recession Watch 25.03.2020

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Headlines

• US Fathom’s new measure of asset valuations shows that asset prices are cheap, but they could get cheaper still
• Equity markets rallied yesterday on signs that the US was close to a $2 trillion stimulus package — the package has since been agreed with a Senate vote expected to pass later today
• However, increasing restrictions in Hong Kong and Singapore highlight the risk of repeated waves of infections that undermine health and wealth in the medium term
• India and South Africa ordered three-week nationwide lockdowns as the threat of COVID-19 rose in key emerging economies

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Fathom has developed a new measure of cross-asset valuations in equity and credit markets. The indicator shows a sharp drop — with our figure now almost 1 standard deviation below normal. On this metric, assets appear cheap. On the surface, this may encourage a ‘buy-the-dip’ mentality. However, they remain more expensive than in the trough of previous historical downturns including the Global Financial Crisis, the aftermath of the dot-com bubble and the early 90s US recession.  While valuations are not always a great timing indicator, the outlook for asset prices, while more balanced, remains skewed to the downside.

Equity markets rallied on Tuesday, with the S&P 500 gaining 9.4% in what remains extremely volatile trading. The uptick appeared to reflect further signs that the international policy response to COVID-19 will be swifter and larger than the response to the Global Financial Crisis. The mood music from DC was that leaders were close to a $2 trillion stimulus package — the Senate is expected to approve the deal later today. Meanwhile, a coordinated statement from G7 finance ministers and central bankers may have also helped to support sentiment. Policymakers have designed large stimulus packages that aim to prevent the destruction of capital, both human and physical, from the consequences of COVID-19. These policies are a necessary but not sufficient outcome for a V-shaped bounceback. However, increasing restrictions in star COVID-19 responders Hong Kong and Singapore in recent days highlight the risk of waves of re-infection. An effective health response will also be required in order to prevent an L or U-shaped recovery.

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Investors may be complacent about the severity of the initial shock that awaits us. Admittedly, markets broadly shrugged off historic declines in survey measures of activity in Europe and the US, released yesterday. However, there remains a risk that investors underestimate the first-round impact on employment. Our forecast for US initial jobless claims for the week ending 21 March is 3 million, which is much higher than the 1 million median of economists polled by Reuters. Evidence from Europe continues to point to an unprecedented negative shock. Yesterday Norway announced that its unemployment rate rose to a post-war record of 10.9% — a figure 8.6 percentage points higher than in February. Meanwhile, research from the Federal Reserve Bank of St Louis said that almost half of US workers were in jobs deemed to be at “high risk” of lay-off due to COVID-19 measures (see reading list below).

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The rise of COVID-19 in developed markets has been closely tracked, but there appears to be an increasing spread in emerging markets. After registering 519 cases, India’s prime minister Narendra Modi ordered a total lockdown of his country’s 1.3 billion population for three weeks. Meanwhile, South Africa will enter a similar lockdown on Thursday. Even without domestic flare-ups of their own, emerging economies were always going to suffer from a sudden hit to global demand and a stronger dollar. There remains huge uncertainty about the ability of countries with fewer resources to cope with the health and economic consequences of COVID-19 that are stretching advanced economy health systems to the brink, and have prompted trillions in policy response. China aside, equity indices in the BRICS economies have lagged their DM counterparts. Until there is further clarity about the economic plans of these economies, this trend may continue.

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Interesting reading

• Research from the Federal Reserve Bank of St Louis suggests that almost half of US workers could lose their jobs due to restrictions implemented to battle COVID-19 
• An alternative epidemiological model from researchers at Oxford University suggests that the spread of coronavirus in the UK may be massively underreported, but that only a small percentage of those infected will need hospitalisation
• Evidence that increased intra-family meetings, particularly between children and grandchildren can help to explain Italy’s high rate of coronavirus cases
• According to a YouGov poll, 5% of Britons have lost their job due to coronavirus

Fathom forecast scenarios

Economic forecasting is difficult even at the best of times. It is particularly difficult today. At Fathom, we think in terms of scenarios and seek, wherever possible, to downplay point forecasts. A severe contraction in global economic activity through the first half of this year is inevitable – we are facing what French economist Pierre-Olivier Gourinchas has referred to as a ‘sudden stop’, something the global economy has never experienced before. But how long will it last? In our Global Economic and Markets Outlook for 2020 Q1, we set out three scenarios. The first was a V-shaped recovery, in which the number of cases peaks within months and begins to decline, allowing activity by the end of this year to return to normal levels. The second was a U-shaped recovery, where the virus continues to spread, depressing activity until a vaccine is found, but the economic and financial market infrastructure remains in place to deliver a strong rebound when that occurs. The third was an L-shaped recovery. If we are not sufficiently fortunate that either science or nature delivers the first of these, then massive government support will be required to avoid the third.