We ought to remain positive in our approach and keep in mind that the economic slowdown is sometimes the best way to speed up
A BILLBOARD outside a cafe read “If you don’t eat here, we’ll both starve” – quotes like these leave us with little doubt that the world is headed towards a Corona-induced recession. When the economy slows, it seems like money also slows to a pause. Businesses don’t hire, wages grind to a halt and no one seems to be giving out work. Families tighten their belt and companies go on an austerity drive—all to ‘wait for the good times to return’.
The current mood on the ground is not helping things either. If you go out and talk to the businessman in the market, anecdotally he will tell you about business becoming smaller, fewer customers are buying and they are buying less. There are pockets of extreme weakness in the world economy. At the most basic level, it is important to recognize that some sectors are very cyclical, meaning they grow rapidly in upturns and fall sharply in recessions and others tend not to fluctuate very much over the course of a business cycle.
The cyclical group is led by housing and non-residential construction, durable goods consumption (cars and big household appliances), equipment investment, and inventories. On the other hand, there are several components of demand that are mostly unresponsive to the business cycle. Spending on consumer services (largely medical spending, FMCG, etc) varies little over the course of the business cycle. This point about the varying cyclicality of different sectors matters for recession predictions, because the highly cyclical components have shrunk sharply as a share of the economy in the last few decades, as the less cyclical components have grown.
While the economy was definitely on a slowing trajectory with trade and manufacturing already affected, the only bright spot was consumer spending. COVID 19 has ensured that families hunker down and go on an austerity drive. While there is a logic to the madness. It takes spending to get an economy going in such testing times.
While the economy was definitely on a slowing trajectory with trade and manufacturing already affected, the only bright spot was consumer spending. COVID 19 has ensured that families hunker down and go on an austerity drive. While there is a logic to the madness. It takes spending to get an economy going in such testing times. After a massive crash like the Great Recession, institutions of all kinds get nervous and hoard cash. As experience now shows, the only organizations the banks lend to in such circumstances are those that already have the money they need. Many small businesses can’t get capital to spend, which helps jump-start the economy. So, central banks have to find new ways to get liquidity into circulation. As in every economic downturn, there is an opportunity behind the crisis. Small businesses with solid fundamentals and enough preparation can ride out the storm—and come out stronger on the other side. At remarkably low-interest rates that are now the norm in many countries, it is perhaps time to borrow and build new infrastructure.
With the economy gradually being reopened, as more industries are allowed to be fully operational such development is heartening. However, there seems to be a sense of discomfort about how the equities market has behaved recently. As the global economy is expected to be in recession this year why the economy and equity markets are not on the same page? The common defense would be equities tend to move ahead than the economy and equity investors will only place their money in companies based on the future earnings. That is why the Price-Earnings (PE) multiples are the main tools for assessing whether the companies’ share prices are selling cheap or it is way too expensive. Agreed that we are not completely out of the woods yet. Lockdowns and uncertainty because of Covid19 could be the possible showstoppers for the equities market. Perhaps, the equities market would experience some correction in the horizon and the prices may have gone up a bit too far. Whatever the case may be, it all boils down to how economic policies are being designed and implemented and how the unknown factors like geopolitical risks, etc would play out. These factors could result in more cautious trade among investors.
As the global economy is expected to be in recession this year why the economy and equity markets are not on the same page?
Generally, people care much more about the psychological pain and anxiety of pandemics than they care about a fall in their standard of living. As per one estimate from the World Bank, using the 1918 Spanish flu as a baseline, the bank estimates that in the case of such a severe pandemic, global GDP could fall by 5%. More than half of that would be because of the disruptive effects of avoiding infection. As a matter of fact, we can do little about the past, the best we can do is to think about the most appropriate remedial action now. It’s clear that the priority is to prevent the spread of the virus leading to various quarantines, lockdowns and travel bans, etc.
What can governments do to mitigate the recession that will inevitably follow from the blockade is a million-dollar question. And the question needs to be answered sooner than later. We ought to remain positive in our approach and keep in mind that, the slowdown is sometimes the best way to speed up.
- Ifthikar Bashir is a freelance financial advisor
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