So far into 2020, the new decade has brought a pandemic threatening to change life as we know it. The rest of the year is marked with key economic and political events destined to reshape the way investors allocate funds.
Recession or Depression
The big question is whether the developed world enters into a deep economic crisis for the next few years. The business cycle theory tells us that after the peak of the cycle, contraction follows, and then recessionary conditions mark the road thereafter.
Sustained recession leads to depression, with long-lasting effects on the prospective recovery when the cycle turns again. Throughout economic history, there were many recessions followed by economic expansion, but fewer depressions.
The GDP forecast for 2020 on developed economies shows recessionary conditions for the months ahead. A recent study by Deutsche Bank says that the world’s GDP will contract by -2.6%. The United States economy is forecast to contract 5.7%, while China to grow 1%.
A sharp rebound into the positive territory is expected in 2021. If that is the case, the world avoids worldwide depression as a V-shape recovery takes place.
This is important for businesses and investors because of budgeting constraints and capital allocation. On a V-shape recovery, investors are willing to shift funds from safe assets in search of risk, and businesses may postpone investments until the cycle turns – but still remaining optimistic.
Monetary authorities will continue to engage in Quantitative Easing (QE) programs. In some parts of the world, (e.g., New Zealand), where the central bank announced it is looking to go beyond classic bond buying. The RBA in Australia tests the QE waters too, while Bank of England announced it is looking into negative interest rates. As a side note, yesterday was the first time ever when the United Kingdom sold bonds at a negative yield.
Governments face higher spending and borrowing levels to cope with high unemployment levels,leading to fiscal policy suffering as taxes are difficult to collect, and tax cuts are granted easier than before. Perhaps the biggest uncertainty of all comes from individuals (i.e., consumers) – high unemployment, lower consumption levels, high savings rates, negative wealth effects, are only some of the concerns for the rest of the year.
Then there are businesses/corporations. Wild fluctuations on fixed and variable costs are likely to negatively affect the cash flow levels and make it difficult to predict.
Finally, all of the above depends on the length and the extent of the coronavirus pandemic. Any good news will positively impact the worldwide economy and financial markets too.