Will corona lead to a financial crisis this time?

Will corona lead to a financial crisis this time?

Published on: 18 August 2020

Senior Strategist Thijs Knaap on the economic impact of a second corona wave

 

As more and more signs are emerging of a wave of the corona virus, the key question for investors is: how heavy will the blow for the economy be this time? And what will be the impact on financial markets? Thijs Knaap, Senior Strategist at APG Asset Management, reveals his vision: “From current prices, it looks like investors in the MSCI World Index think that corporate profits will be back at the pre-crash level within two years’ time.” 

 

As an investor your mind is constantly occupied with the question to what extent  information is reflected in the price of a certain investment category or index. Given the global economic impact of the corona pandemic, it only seems logical that Thijs Knaap is pretty occupied with the question: What will be the economic consequences of a second corona wave?

 

To what extent do equity markets already reflect the economic consequences of a second wave?

Knaap: “Everyone of course has different models and projections, but the current consensus is that the companies in the MSCI World Index will be making approximately thirty percent less profit this year as a result of the first wave of infections. But then again, the price of a share is also determined by profit expectations beyond 2021. Based on all of those expectations together, investors in the MSCI World appear to assume that corporate profits will be back at the pre-crash level within two years’ time.”

 

That is rather quick.

“Yes, but don’t forget that relatively few companies had to file for bankruptcy and that we are not in a financial crisis at the moment. And that has everything to do with the monetary and fiscal policy of national governments. Central banks are really stimulating the economy, with the result  that credit is cheap. That is the monetary part. In addition, there are many government regulations in place that enable companies to continue salary payments, such as the NOW-arrangement in the Netherlands. This fiscal policy has also contributed to the survival of many companies.”

 

How sustainable is that policy?

“Well, that is indeed the question. Should a second wave of infections emerge, then expected profits will further decrease in the short term. That is not pleasant, but two years of decreasing corporate profits is manageable. More important is the question of whether that second wave will be leading to a financial crisis or a wave of bankruptcies this time around. That will depend on the response of governments. They could continue the monetary policy for a while, but fiscal policy is quite a different story. The upcoming elections in the United States may lead to a Senate and House of Representatives with different political colors which means a second round of support measures could prove to be difficult - and don’t forget that the first round of support measures was already very difficult to establish. In Europe, considerable efforts were needed to reach a deal  (about the EU budget up to and including 2027 and a corona fund, ed.), but that meant spending most of the available political capital. Debt ratios (debts as a percentage of the gross domestic product, ed.) are already increasing considerably, reducing the margin for governments to maintain a fiscal stimulus. And that margin is definitely smaller in emerging countries. Anyway, the stock and bond markets are not ready for a second similar wave of infections that will indeed lead to a financial crisis or wave of bankruptcies.”  

 

This means the markets are not yet taking this into account?

“No, the markets appear to assume that the second economic blow will be less severe than the first one. That is not unreasonable. We know a lot more about the spread of COVID-19. Complete lockdowns are becoming less likely. More differentiated, restricted lockdowns will be implemented. The economic damage of those lockdowns is smaller, and a vaccine is being developed as we speak. There are fewer uncertainties which means the economic consequences of a second wave will be considerably less.”

 

Could we still get an unpleasant surprise?

“Yes, winter is coming during which the virus could spread much faster because people are spending more time indoors. And also the long-term effects of the virus on people’s health appear to be significant, but most of those consequences remain unknown for now.”

Published in these collection(s)

Financial Markets

Collection in Long-term investment