The Likely "Flash" Economic Recession
by Patrick Oberhaensli, on Apr 6, 2020 4:15:00 PM
A recession is typically defined as two consecutive negative readings of real (not nominal) GDP growth, and that's exactly what numerous countries and regions, including economically important areas in Europe and the USA are expected in March 2020 to enter into – the effective readings coming later on. In this article, we will focus on the possible or rather a likely large scale sharp recession that's coming (or is already here) and what comes afterwards.
Coronavirus: An exceptional situation, with historical parallels
The single trigger for the drastically accelerated economic slowdown is certainly attributed to the coronavirus. Despite the fact that in China, where it apparently all started, new cases are steadily declining, the pandemic situation is still developing exponentially here in Europe as well as throughout the "globe". It should be noted, that such an event isn’t extremely rare as the rather low volume of issued pandemic-related catastrophe bonds indicate (the issuing size being only of several 100 mn USD, a few years ago). Moreover, besides the important ethical matter, these cat-bonds can hardly be seen as uncorrelated to equities particularly when the trigger is a virus of large scale (with high contagion and health impact).
For the moment, at least, there are no apparent signs that the virus will have an “unexpected” development if the sanitary conditions set by countries/regions are extensive, coordinated, and well followed (when it comes to Europe, it is considered as a single region, but the perspective should be much larger).
On the other hand, if the appropriate sanitary measures are not taken within the necessary time frame or if the population does not comply with regulations– something that we are unnervingly seeing across many regions, we could see consequences (far) beyond what is “expected”.
The last piece of the pandemic process revolves around the Research and Development efforts, in particular the rapid development of a vaccine. Clearly the Research and Development efforts go beyond the vaccine and might be effective for containment (although this still remains unknown for now).
Monetary and Fiscal Effects
Concretely looking at the situation, it can be assumed that economies will “anyway” be moving forward at a very slow pace for a number of weeks or rather months. The industries expected to suffer most are transportation, including the cruising industry (which saw its stock prices massively drop in value) and energy/oil related companies. But this is only from a high level view. With the global containment approach of “social distancing”, the affected industries and companies – especially of smaller size - continue to rise, including more and more non-food physical retail as well as the leisure and event industries. Therefore, rapid and decisive economic measures are necessary from both the monetary & fiscal sides in order to mitigate the negative effects associated with the adoption of sanitary measures.
At the time of publication, these two sides, monetary and fiscal, have not yet been placed into effect at the looked-for level on a quasi-global basis (the real dimension). The consequences can certainly be felt at the level of the stock exchanges with the rise in extreme volatility and losses. This is all while considering that containment measures still vary quite a lot from one country/region to the other. Will more consistency eventually happen? That’s highly likely – including possible overshoots in some countries.
What comes afterwards?
That’s an important question as well! The very high/extreme volatility regime will again normalize. Opposed to what happened for the Great Financial Crisis, the recent history breaking record closing of the VIX on March 16, 2020 has not been followed by a second one (and as of 20th of March there has been no reading above 80% since then). But equity markets will be anticipating the improvement of the situation (well) before it has completely stabilized. That means that many advisors will consider buying stocks again in a step by step approach, but only after a sharp fall has occurred – which is the case now (March 2020). Other investors will wait until a “tangible proof” of a reverse of the situation is given: the problem here is to identify what a tangible proof is exactly when it appears.
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The current crisis is, from an economic point of view, a crisis that can essentially be mastered using the same economic tools as 12 years ago during the Great Financial Crisis, of course with additional modern advancements. But the adapted measures (on a very large scale) must be applied as soon as possible – and not step-by-step (which is what is typically done from a health security aspect). In that context a “V” or “U” shape move of the economic can be envisaged.
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• The preparation of the information provided herein is done with a high level of care. Nevertheless, errors are possible