COVID-19: what does an economic recovery look like?

investment insights

COVID-19: what does an economic recovery look like?

Samy Chaar - Chief Economist

Samy Chaar

Chief Economist

Four long months have passed since the COVID-19 virus ground the world to a halt. Today, many parts of the world are battling hard to ward off the virus’ contagion whilst others are working hard to maintain the precarious control they have. In short, the world is still reeling with the effects of the virus and many uncertainties remain. But the question is what will the economic recovery look like?


Is the worst behind us?

The health crisis isn’t over and we have to remain vigilant. At Lombard Odier we track all of our scenarios and identify key indicators using daily data to give us a near real-time overview. We know there will be long-lasting consequences but we are convinced that the pandemic serves to exacerbate trends, not create them. And with that in mind we can strategically position our portfolios. 

We know there will be long-lasting consequences but we are convinced that the pandemic serves to exacerbate trends, not create them

Living with the virus

In recent times, it has become clear that countries and regions must utilise all the tools they have at their disposal to protect themselves against the coronavirus. There are some key tools that should be used in order for nations to continue to gradually opening up their economies and keep the situation under control. Firstly, there needs to be robust testing, tracking and isolating of those who are infected. This keeps clusters of infections small and manageable so they do not turn into outbreaks. Secondly, improved hospital capacity is key to managing the health crisis. Thirdly, social distancing has proven itself – wearing masks and maintaining distance where possible can help curb the spread of infection. Finally, we see scientists and pharmaceutical companies working hard to improve their understanding of the virus and finding new ways to combat it via drugs or in the race for a vaccine.  

Asia and the European Union seem to have the situation largely under control and have contained clusters that have broken out…

The two sides

Controversy and the coronavirus seem to go hand in hand. We have seen different regions opt for different approaches. In general, there are two types of responses: those countries who responds using the above-mentioned tools and who are managing to contain the virus and those who are not. We have seen thus far that Asia and the European Union seem to have the situation largely under control and have contained clusters that have broken out, for instance in South Korea and China. This works to prevent a disruptive second wave and we expect those countries to continue to succeed. Other countries such as the USA, Sweden and India are dealing with a large number of daily cases but are either unable to or unwilling to collectively use the necessary tools to handle COVID-19. The USA has seen some states violently oppose lockdowns or social distancing which will result in a delayed recovery. It cannot be called a second wave as such because the first wave has yet to be dealt with.

Other countries such as the USA, Sweden and India are dealing with a large number of daily cases but are either unable to or unwilling to collectively use the necessary tools to handle COVID-19

What does recovery look like?

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Tracking the recovery means identifying where an economy was before the crisis and comparing it to now or where it might be at the end of 2020. We use an average of seven indicators across business, trade, production, consumption and mobility. Take China for example. Now it is at 91% of its pre-Covid activity but at the peak of the virus, and at the trough of its economic activity, it plummeted to 39%. These numbers are telling as we see the recovery has been swift but the economic shock has been deep.

Europe tells a similar story. At the peak of the virus, economic activity fell 50% but as of June, the EU is at 75% of its economic activity. The shape of this part of the recovery looks like a V. Why? Because we went from lockdown to opening up our economies so there was a surge in activity. Soon, this V-shape start will likely resemble a different outline and take the form of a square root as we work to catch up the residual economic potential over the coming quarters and into 2021. Our base case scenario is that we expect to reach 90% of economic activity by the end of the year thus we should exit the recession in the third quarter of this year. There are certain sectors that may take more time to rebound such as the travel, tourism and restaurant industry and we expect that the remaining 5-10% activity to take much longer to recover.

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Our base case scenario is that we expect to reach 90% of economic activity by the end of the year thus we should exit the recession in the third quarter of this year

On the other hand, there is a possibility of a more risky scenario where we are faced with a disruptive second wave and we are forced to go back into full lockdown. We see this scenario less likely given we have the tools at our disposal in order to better manage outbreaks of the contagion. Conversely, there is a possibility of a more positive scenario where we have a medical breakthrough and find a vaccine or drugs to cure the effects of the virus more quickly than expected. 

Post-COVID world

We are under no illusions as to the fact that we will recover to a world of slow growth, inequality, debt (albeit sustainable at these interest rate levels), benign inflation and low/negative interest rates. This is not a world dissimilar to the one we were familiar with pre-coronavirus. However, we cannot be complacent about the risks. For instance if policy or government support is withdrawn too soon from economies in the form of rate hikes or a reduction in stimulus checks, it could trigger a recession. In the USA, although 20 million people lost their jobs due to COVID-19 and 18 million people have been temporarily laid off, personal income went up. How? Due to government support. Another secondary risk to consider could be potential protectionism if countries seek to increase trade tariffs for instance.


Managing our portfolios

Our base case is one, we believe, is already being priced into the markets. Using the US market as a major indicator, we have a slight underweight in equities, favouring emerging Asia and US, as well as the IT and healthcare sectors. In EU equities, we are underweight as the finance, energy and the industrial sectors, prevalent in European indices, are less attractive in the current environment. We have less conviction in emerging market debt, given low oil prices. Taking into account external volatilities, we have put options on equity indices in place for our portfolios. We also have an overweight in gold and given the depreciation of the USD, we see the Japanese Yen against the dollar as a safe haven.


And in the long term?

There are significant challenges, and opportunities, that the world is facing that are influencing long-term trends. We cannot deny the fact that there is a climate emergency and we need to invest in the climate transition. We have to act quickly and decisively as we only have approximately seven years left of carbon credit. Transport electrification, clean mobility and companies who are already of the path to net zero are interesting areas of investment.  We do favour companies who ask themselves whether how they do things or what they do, helps to resolve the major sustainability issues that our world is facing.

We cannot deny the fact that there is a climate emergency and we need to invest in the climate transition

Another long-term trend lies in demographics. Outside of India and Africa, globally, we see a diminishing working age population, which affects consumption patterns and the health care industry. These areas are interesting in terms of investment looking at themes such as robotization and medical technology.

The emerging power of China cannot be underestimated. China now represents around 20% of the world economy and we believe our clients should benefit from this development through a dedicated, strategic allocation.

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