Causes of Ongoing Uncertainty

Published: 25th March 2020 (5 Min Read)

There is some much-needed relief in equity markets, but we are not yet out of the woods by any stretch of the imagination. Today I am listing some of the ongoing concerns which people have and am trying to address them briefly. I am sure that there are others, not least fear of both illness and its effects upon wealth.

1. Daily COVID-19 infections rates are accelerating in the US and they remain extremely high in Europe, even if they are now very low in China, South Korea and Japan.

• Testing in the US has been slow and poorly adopted. This has retarded social distancing and the rise in infections is likely to be steep.
• Europe has a mix of rising and flattening trends of infection, but is far from turning the corner
• China is easing controls internally, but in a limited fashion so that they can monitor the risk of new incidence of infections. Incomers are being quarantined to reduce the chances of reintroduction of infection. People are going back to work.
• Until we see falling global rates of infection, which is some way off, it is reasonable for people to feel anxiety about the length and depth of the recession, which is certainly upon us.

2. How bad is the recession going to be?

• Impossible to answer, but the sharp deterioration should be followed by a rapid improvement.
• The risk to that optimistic scenario is that the longer the downturn persists the greater the impact upon society and economies. In particular secondary effects upon companies which are not in the front line in the early stages become more likely
• More likely to be a glacier-shaped U than a river valley-shaped V recession.

3. The authorities are now rapidly promising huge aid packages, but how do these aid packages find their way to the people that need aid? This is what is missing.

• This is a very good question, and impossible to answer given the numerous destinations.
• Governments are feeling their way, and developing the implementation of policy as they go, so it is difficult for them to reassure completely, despite the intention being very clear

4. Some people believe that throwing money at the problem is a wrong response – it will cause inflation and doesn’t deal with debt outstanding

• I disagree about inflation in the short run. We are in a sharp deflationary contraction and only the provision of enough money to the pinch points of the system can protect both local and global financial systems.
• Much of the financial assistance will be withdrawn when recovery happens, but in the medium term we are seeing a switch from economic dependence upon monetary policy to a mix of monetary and fiscal policies. Fiscal choices will fuel growth, especially in infrastructure. This raises the probability of higher inflation, but doesn’t guarantee it.
• I agree about debt. It will grow very substantially. I have written previously on why QE is needed to enable the growth of debt, but if a substantial portion of future government spending goes into infrastructure investment then this will be a supply side, and possibly environmental, benefit. I believe it will be.
• There will be some products whose prices rise sharply in the short term, due to supply chain issues.

5. China’s economic performance in Jan/Feb was far worse than predicted.

• Yes, it was, but it is possible that there will be quarter-on-quarter growth in Q2 as domestic consumption and investment pick up

6. There is hidden leverage in company balance sheets, and the breakdown of global trading means non-US borrowers cannot repay their dollar debts.

• This is a real concern, but the Fed has been very attentive to this specific issue

7. Central banks may be making money available to commercial banks, but will the latter make loans, and will they do so at a rate that the authorities would like?

• Maybe, maybe not, but if it’s the latter then the default cycle that everyone is fearing could suddenly arrive.
• This is one reason why monetary and political initiatives need to be coordinated. In the UK we can see that the Chancellor and the Bank of England are working together to avoid this risk. In the US it seems Congress has agreed a package of up to $2 trillion, but we don’t have details yet.

8. Fears of the end of globalisation.

• This simply is not going to happen, but new trends are arriving, partly because technology allows the replacement of cheap labour, and partly because as growth in consumption in Asia starts to be the main driver of Asian economies their focus shifts to being regional.
• Environmental concerns are likely to support localisation, but demographics and resources will temper the degree to which it occurs

9. Companies will hoard cash, not pay dividends and cease buying back their shares

• Certainly, a number of companies have already made announcements to this effect, and social distancing will cause delays to some AGMs, which may delay authorisations to pay dividends or buy in shares.
• This is a shareholder issue, rather than an economic one, except where it is of corporate necessity. This should largely be a precautionary exercise, unless the downturn persists for too long.

10. The Saudi v Russian production battle and the OPEC v US shale price war brings unhelpful credit stress now, even if it should bring consumer relief later.

• It is important to recognise that the highly indebted shale companies could become insolvent. Other parts of the high yield market should not be so much at risk, so long as business activity bounces back reasonably quickly.
• However, the quality of the various levels of debt rating is also historically low. Care is needed
• The risks here are obvious, and so the Fed is stepping in, but they won’t buy everything, so be careful.