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Equity markets rallied through the first two days of this week amid hopes that the COVID-19 outbreak was reaching a peak in Europe. By close of business yesterday, the S&P 500 had recovered almost 20% from its trough in late March.
The COVID-19 statistics published by various national agencies, and collated by Johns Hopkins University, can be erratic from one day to the next. As an example, the number of deaths registered in the UK had fallen for two days in a row, reaching 439 on Monday. But yesterday’s data showed a jump back up to 786, a new high. The figure published yesterday reportedly included a large number of deaths that had occurred over the weekend, when fewer staff were available to process the data. In an attempt to control for this issue, we look at the average number of deaths over a seven-day period in the chart below. Although we see clear signs that the number of deaths has peaked in Italy and in Spain, that is less obviously the case in the UK, the US or France.
A number of European countries, including Austria and Denmark, have begun to discuss lifting at least some of the restrictions that have been imposed in recent weeks. Singapore, which had used a thorough programme of testing and contact tracing to operate almost as normal, yesterday took a step in the opposite direction, closing all schools and most workplaces. The impact on movement can be seen clearly in the Citymapper Mobility Index, which we have reproduced in the chart below.
Reopening for business is not without its risks. These can be minimised by frequent testing – not only for active cases of the disease, but ideally for those who have caught COVID-19 and recovered. A successful antibody test would enable the creation of so-called ‘immunity passports’. The difficulty, however, is that these are far from infallible. In a recent blog post, Tom Chivers set out the statistical difficulties that are involved – see below for a link. Essentially it is an application of Bayes Theorem. Imagine a test that is 95% effective. That is to say, there is a 5% chance that it will wrongly identify someone who has not had the disease as immune, and vice versa. This sounds pretty good, right? But now imagine the case where, in truth, 3% of the population have caught COVID-19 and recovered. We test a million people at random. 970,000 will have had the disease and 30,000 will not. But can we find them? Of the 970,000 who have not been infected, our 95% accurate test will wrongly identify 48,500 as immune. Of the 30,000 who have been infected, our 95% accurate test will correctly identify 28,500 as immune. So close to two-thirds of those who appear to be immune will not be. And that is with a test that is 95% accurate. The 3.5 million tests recently purchased by the UK government are reported to have an accuracy rating somewhere in the 50%-60% range! These tests are approximately worthless.
Earlier this week, we updated our assessment of the likely initial impact on economic activity of the lockdowns that are now in place across many economies, and concluded that the global economy is undergoing an economic contraction on a scale that has not been seen since at least the Great Depression of the early 1930s. Survey indicators provide a timely reminder of the pace at which events are unfolding. In an update to their usual March survey, GfK found that the confidence of consumers in the UK economic outlook had fallen to a new record low in the space of one month.
The drop in economic activity that is unfolding is, for almost all of us, an order of magnitude greater than we have ever seen before. That does not mean, however, that we are facing a recession that is more severe than anything we have ever seen before. Our best guess is that the UK, for example, will suffer an economic contraction of some 25% through Q1 and Q2. That would take us back to 2001 levels of economic activity. So, for a period of time, which may be no more than a few months, we will as a nation be no better off than we were back then. But 2001 was OK, at least as I remember it.
What is crucial is that governments around the world step in to support those firms, and those workers who have been severely affected by the lockdown, so that they are able to swing back into business once the restrictions are lifted. In a forthcoming Fathom the Forecast, we argue that this is likely to cost somewhere in the range 15%-50% of annual GDP. A large sum of money, undoubtedly, but in the vicinity of the increase in government debt that took place across the major economies in the aftermath of the Global Financial Crisis, as illustrated by the grey shaded area in our chart. The risk, if we do not put in place the necessary support packages, is that the likely 25% contraction gets locked in, and we endure an ‘L-shaped’ recovery.
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. Since we finalised our forecast on 17 March, a number of major economies have placed more severe restrictions on movement, and imposed a temporary shutdown on more industries than we had thought likely. This more aggressive action has caused us not only to anticipate an even sharper contraction in economic activity in the first few months of this year, but to increase the weight we attach to a V-shaped recovery. At the same time, we have also increased the weight we attach to our more severe risk scenario, making the outlook somewhat bimodal. In the event that COVID-19 returns with equal or greater vigour once restrictions that are holding back economic activity are lifted, then a severe financial crisis will be very hard to avoid.
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