During 2020 the world economy shifted from a position of strong growth to severe global recession. Although this is clearly a significant concern, recessions are a normal part of the economic cycle so it is important to look at this in the right context to understand what is occurring now and what might happen next.
So, what is a recession? A recession is defined as a significant decline in economic activity within a specific region. The generally accepted method of declaring a recession is two consecutive quarters of Gross Domestic Product (GDP) contraction. However, Government agencies, such as the Office for Budget Responsibility (OBR) in the UK also consider other indicators, such as industrial production, employment, and real levels of income.
If a recession enters a deep and prolonged phase then it may be termed as an economic depression. A depression can last longer and be more difficult to recover from.
There are three main types of recession:
Cyclical – A regular decline in the business cycle, often driven by periods of excess confidence. Alan Greenspan, the former Federal Reserve Chairman, defined this as a period of irrational exuberance. In simple terms, we can look at this as what goes up must come down.
Structural – More serious and generally caused by a disconnect between supply and demand components within the economy. This type of recession can take a long time to recover from or require intervention from governments to resolve problems.
Event-Driven – A recession triggered by an event such as war, shock to the oil price, emerging market crisis, or famine. These types of recessions would normally be expected to be easiest to navigate as the underlying economic forces should be in good shape for the economy to snap back once the event in question has passed or been resolved.
The current recession facing the UK and the rest of the world clearly constitutes an event-driven recession brought about by the COVID-19 pandemic and the collapse in the global price of oil.
Lockdown policies have severely dampened a huge amount of economic activity. The UK is on track to record the largest decline in annual GDP for 300 years. The OBR’s mid-range estimates show GDP falling by 12.4% and unemployment hitting 11.9% during 2020.
From a fiscal standpoint, this means that economic recovery is highly dependent on government policy. If lockdown measures are continued on a national or localised basis any economic recovery could be stymied, prolonging the recession.
During the initial period of lockdown, the Chancellor unveiled a series of fiscal stimulus measures to support businesses and individuals. It is likely that further measures will be required.
Whilst economies have faltered stock markets globally have bounced back from their initial lows and are at or close to pre-pandemic levels, something that we predicted in late March.
Our expectations are for continued volatility throughout 2020, due to ongoing uncertainty around the COVID-19 pandemic and the forthcoming US elections. Beyond this we expect to see stock markets show continued growth, driven by several factors:
Growth in key sectors – A number of sectors are benefitting from, or are likely to benefit from, the recessionary forces in play. These include sectors such as pharmaceuticals, biotech, surveillance technology, artificial intelligence, and non-cyclical consumer staples amongst others. Not only do we expect these sectors to benefit from current events, but this will mean that the largest companies in these sectors will become larger constituents of the stock market indexes they trade on. This will have a direct bearing on client portfolios, potentially driving growth.
Consolidation – Lockdown policies have favoured economic performance by large multinational corporations, often at the expense of small local retailers. Particularly in the sectors outlined above, we expect large cash-rich corporations, such as Amazon, Microsoft, IBM, Alphabet, Facebook, and Palantir to aggressively expand their market share and to buy up emerging technologies, innovative start-ups, and competitors; consolidating market share into a smaller number of larger players. Again, when viewed from a stock market index perspective this will concentrate growth for the benefit of investors.
Structural – Although global economies have seen large-scale falls, this has been accompanied by further reductions in already ultra-low interest rates, colossal scales of quantitative easing and fiscal stimulus, and large-scale government contracts. These factors, combined with the huge abundance of ultra cheap oil across the world, create a set of conditions that will likely drive strong recovery in the corporate sector over the coming months and years.
The scale of economic damage to the underlying economies of many countries, including the UK, could be vast with large-scale unemployment causing a huge range of societal and economic problems. From an investment standpoint, we see lots of reasons for investors to remain confident about prospects for growth. Those who hold their nerve and take a medium to long term view of their investments should be rewarded for their patience and bravery.
