Macro update

Investors and analysts are carefully examining economic tea leaves for signs of what is to come but confusion still reigns. We believe that this uncertainty reflects the unique circumstances currently faced and is likely to persist. The market needs to accept that for now, “we just don’t know – yet”.

• “Hard” economic data arrives too late and “soft” economic data is too volatile to give clarity when events are as fast paced and unprecedented as they are today.
• The data points we have gotten are extremely negative but are difficult to interpret in the absence of any historical comparison.
• Markets will remain focused on conjecture and narrative rather than measurement and data for the coming months. As a result, forecasting will be difficult, but markets will provide both risk and opportunity.

What is the data telling us? Not much, as of yet

The financial markets are intensely focused on measuring the scale and trajectory of the economic impact of the coronavirus. However, because of the inherent limitations in economic data, the key message is still that “we just don’t know – yet”. Interpreting the data in the current environment is made difficult for three reasons; the lag between data measurement and economic activity, the geographical pattern of the epidemic, and the incomparable scale and speed of the moves. Anybody who insists they know what is happening based on the data has only demonstrated that they don’t know what they don’t know. As a result, markets are still trading on conjecture instead of measurement, though gradually the fog is beginning to lift.

The highest quality “hard” data (e.g. counting widgets produced, profits reported on tax returns, etc.) is reported with a lag, and is somewhat backward looking. More timely but lower quality “soft” data is available, but this is generally survey data (e.g. sentiment, PMI, etc.) and therefore volatile and often distorted. The highest frequency, but least reliable economic indicators are the financial markets themselves (e.g. equities, rates, etc.) as they embed not just expectations for future activity, but also investor psychology, risk and liquidity constraints and other sources of noise.

As the US has been one of the last countries to be hit by the virus there is as yet very little data on the impact.

Additional complexity is added by the rolling geographical nature of the outbreak. China was the initial epicentre and thus is the first to report data, but Chinese economic data is widely regarded as extremely unreliable. US economic data is generally seen as the most complete and accurate, but as the US has been one of the last countries to be hit by the virus there is as yet very little data on the impact.

Finally, as these events are without contemporary precedence, there is no reference point against which to measure and thus interpret the data we do have.

The data we have been given is grim

At the moment, we have had a lot of reaction from financial markets, a few soft data points and hardly any hard data points. The initial market reaction to the spread of the coronavirus from China to Europe and beyond is well known – the sharpest risk-off move in global markets in decades, followed by the swiftest partial recovery in years in part because of an unprecedented correlated, if not coordinated, collection of fiscal and monetary stimulus measures.

On the soft data front, the news has been grim with one glimmer. The China PMI surveys for February were closely watched as the first major soft data report from an affected country, and they showed an unprecedented decline reflecting the temporary closure of large parts of the economy. Early PMI reports for March suggest a rebound in activity in China, and a glimmer of hope that the end may be in sight. However, we remain cautious. A PMI survey is a useful indicator under normal circumstances, but these are not normal circumstances. The PMI basically asks firms “do things look better than they did last month”; the survey doesn’t even try to ask “how much better?”. In China last month, many, if not most firms had shut down. This month, many have reopened. If only one customer has come through the doors following a month of closure, that will show up as a positive response on the PMI survey.

Source: China National Bureau of Statistics, March 2020

As the soft data surveys have rolled westward to Europe along with the virus, the news gets grimmer.  The flash PMI for Germany for March, for example, plummeted from for 50.2 to 37.2, broadly consistent with the decline in China from February. The ZEW business survey (an indicator of economic sentiment in Germany) confirms the message, as do business and consumer surveys throughout Europe.

Weekly jobless claims in the US soared to the 3.25m last week, which is so large it was previously unimaginable.

The world’s largest economy was also one of the last to be hit with full force of the coronavirus and yet the US is also the source of one of the only hard data points yet available. Weekly jobless claims in the US soared to the 3.25m last week, which is so large it was previously unimaginable. In the sixty-year history of the series, US jobless claims have never gone above recession highs of 700k. It is difficult to interpret this kind of a number. Nearly five times the previous peak – is that a lot, under the circumstances? It is difficult to say.

Source: US Department of Labor, March 2020

In weeks and months to come we will continue to get more clarity on the extent to which global economic activity has seized up. Given the severity and swiftness of the shock, the data will continue to have little historical precedent and thus remain difficult to interpret. Investors will therefore have to develop new playbooks rather than pulling out patterns from old ones.

Narratives, not data, are the focus at present

Going forward, we believe there are three key narratives that investors will focus upon. The first is the course of the epidemic, the second is the extent and effectiveness of the policy response and the third is the depth and duration of the economic downturn.

The primary narrative at present surrounds the coronavirus – how fast it is spreading, whether it is peaking and how far we are from either a vaccine or herd immunity. There are tentative signs that the infection rate may be peaking in parts of Europe and a peak in the US will be seen as a welcome sign for markets. However, investors will remain wary of the potential for infection rates to rebound as and when social distancing measures are relaxed. Accordingly, the virus will remain a concern until a global vaccine and/or herd immunity is developed.

While the size of the stimulus is massive, so is the gap to be filled by the slowdown in the global economy.

The second narrative that investors will attend to is the rollout of the stimulus packages, both fiscal and monetary. Globally, approximately $5tn of fiscal stimulus packages have been announced, with only China (with somewhat less fiscal room to manoeuvre) left to join. Broadly speaking, work by Morgan Stanley suggests this is likely to push the G4+China cyclically-adjust primary fiscal balance to around -8.5% of GDP. This compares to -6.5% of GDP in 2009, in the depths of the “Great Recession”, and a more normal range of -2% to -2.5%. While the size of the stimulus is massive, so is the gap to be filled by the slowdown in the global economy. What remains to be seen is if the stimulus will prove big enough, if the distribution of funds will be effective and the long-term impact of the surge in public sector debt.

On the monetary front, we have seen a massive injection of liquidity from central banks around the world with balance sheets at the Federal Reserve, European Central Bank, and Bank of England expected to expand by about $6-7 trillion. We believe the goal here is not to stimulate activity – if people are quarantined and businesses are closed, low borrowing costs won’t get consumers into shops or get factories producing goods – but rather to mitigate the liquidity shock of the sharp sell-off in risk assets and to allow for an unimpeded (by liquidity) recovery when the virus shock recedes.

The final narrative concerns the extent and the duration of the global economic downturn. The coronavirus has prompted an unprecedented event, the economic equivalent of a medically induced coma. Historical patterns in the data won’t provide much guidance in the current environment. Instead, logical reasoning and economic theory will have to underpin analysis until enough data is collected to validate or invalidate hypotheses. For this reason, markets are likely to remain difficult to forecast for some months – resulting in both risk and opportunity.

Investors and analysts are carefully examining economic tea leaves for signs of what is to come but confusion still reigns. We believe that this uncertainty reflects the unique circumstances currently faced and is likely to persist. The market needs to accept that for now, “we just don’t know – yet”.

Next steps

• If you have any questions please consult your Dolfin relationship manager.
• To browse our recent investment research, visit dolfin.com/research.
• If you would like further information, please join us for our quarterly investment outlook on 7 April (visit dolfin.com/events) or watch the recording afterwards.