4 Covid-19 scenarios and why remaining invested is still the best option
Investments economists have mapped out four economic recovery scenarios to assist investors in assessing their investments during these turbulent times.
V-shaped recovery – bull case scenario
In the first scenario, Sanisha Packirisamy, economist at Momentum Investments explains, a V-shaped recovery is considered. “In our view, this is a scenario in which the globe undergoes a rapid growth slowdown in the first half of 2020, followed by an equally rapid recovery from the middle of 2020, as the virus spread is contained, allowing annual growth rates to fully absorb the shock. This scenario requires strong public health structures and highly effective policy responses, which ultimately lead to a strong rebound in economic activity.
This is the best-case scenario and in line with recoveries seen in most prior epidemics over the last century.”
For this scenario to unfold, Packirisamy notes, either a pharmaceutical breakthrough is required, or government measures need to prove effective in containing the spread of the virus by the second quarter of 2020. This means that restrictions on movement are lifted quickly and disruptions in supply chains are limited to the first half of the year, with normal production resuming around the middle of 2020.
However, with the Imperial College London COVID-19 Response Team modelling a peak in deaths in the US only in June 2020 (if inadequate control measures are taken), the likelihood of a V-shaped recovery taking hold with only a short-lived dip in global demand is looking increasingly unlikely.
U-shaped recovery – base case scenario
“In the second scenario, we could see a delayed and sluggish upturn following a more protracted slowdown,” Packirisamy continues.
Under the U-shaped scenario, disrupted global supply chains are only restored subsequent to the peak in COVID-19 fatalities in the third quarter of 2020, resulting in an economic recovery only taking hold from late 2020 and extending into 2021.
“In terms of our modelling, the response from policymakers in this scenario is only partly effective, while the negative effects on unemployment and business operations muffle the economic recovery. We would expect China to emerge from recessionary conditions faster than the US and Europe, given the earlier peak in infection rates observed in China.”
Protracted U-shaped or double-dip W-shaped recovery – bear case scenario
“A protracted U-shaped or double-dip W-shaped recovery is our bear-case scenario,” Packirisamy continues. “Under this scenario a second wave of the COVID-19 outbreak flares up globally and in South Africa, with quarantine measures extended to more regions and for longer. In addition, new cases could rise in other parts of the world, despite a change in seasons, dragging out the peak in global infection rates. A re-emergence of disruptions in supply chains are likely under this scenario and these bottlenecks would exacerbate and prolong the downturn in local demand and exports. This would, in turn, negatively affect corporate profitability, with corporate credit risks rising as a consequence.
“Severe restrictions on normal economic activity would prolong the downturn in economic activity well into 2021, with the rebound in growth more drawn out,” she says.
L-shaped recovery – black swan scenario
“Under the fourth scenario significant permanent structural damage occurs on the supply side of the global economy, either in the labour market, in capital formation or in the productivity function,” Packirisamy continues.
“In an L-shaped recovery, an insufficient public health response allows for a further spread of the virus for an extended period, while policy measures fail to prevent widespread unemployment, insolvencies, credit defaults and instability in the financial sector.”
Packirisamy explains that the recovery in growth would be like the Great Depression, where the nature of a deeper recession in economic activity results in several credit events, such as a significant rise in corporate defaults and corporate bankruptcies, and a material increase global unemployment.
However, she notes that this scenario is the least likely outcome, as parts of China have already seen a relatively quick restart in production. Similarly, the probability of severe financial dislocations remains less likely, given governments all over the planet’s efforts to shore up liquidity.
What does this all mean for investors?
“As the selloff intensified during March, we have witnessed traditionally defensive asset classes, including local government bonds, not emerging unscathed. History has shown that asset class returns tend to move in unison during times of extreme volatility and it is no different this time around,” says Marais However, she believes that once the virus effect has played out there will be a significant rebound in global economic growth and company profitability. This in turn will ignite renewed risk appetite by global investors.”
Most importantly Marais notes that, during times of uncertainty, clients must focus on their long-term investment goals and guard against overreacting to short-term events.
“Selling into market weakness locks in paper losses and also exposes investors to the risk that they miss any eventual rebound in markets,” says Marais. She emphasises that it has been proven time and again that the prudent and lucrative investment strategy during these events is to ‘stay invested’, rather than attempt the timing of markets.
“At Momentum we are unwavering in our belief that a well-constructed diversified fund is the most effective way to achieve your long-term investment goals. We also know that opportunities will present themselves to enhance long-term returns for our clients by taking advantage of dislocations in asset prices.
In the meantime, we will continue to update our clients as events unfold, but we want to assure them that we remain vigilant and responsive to market events and that we will stick to our outcome-based investing process and philosophy with diligence,” Marais concludes.