The Shape of U?

As governments, corporates and individuals struggle to come to terms with the ramifications of the coronavirus pandemic, the International Monetary Fund (IMF) has issued a stark warning that the ‘Great Lockdown’ will result in the biggest economic downturn since the Great Depression. In such unprecedented times, many questions are being asked – how are economies navigating through the uncertainty, when will ‘business as usual’ return, and what shape will countries, companies and households be in when we emerge on the other side? – but few answers are available until we have greater clarity on the effectiveness of containment measures and the development of treatments and vaccines.

Economists and forecasters are analysing a multitude of high-frequency data points, to test the health of the global economy as we move through the crisis, and are modelling the probability of a range of outcomes for the shape of the recovery from here.

Depending on the nature and timing of the data being analysed, a case can be made for a number of recovery scenarios: from the fabled ‘V-shaped’ recovery where a sharp decline is followed by an equally-strong bounce back – like that witnessed in the 1953 US recession; to a more modest ‘U-shaped’ recovery with a less-defined trough and extended bottoming out – akin the 1973-75 US recession (and the likes of which the UK Treasury has warned of more recently); to the much-touted double-dip ‘W-shaped’ recovery where we could see markets retest their 2020 lows as near-term earnings are revised down, and companies endure greater-than-anticipated economic pain prior to any rebound on medium-term earnings growth expectations – the European debt crisis that followed hot on the heels of the Global Financial Crisis being a good example.

Given the sheer volume of fiscal and monetary support globally, few are entertaining the prospect of a more prolonged downturn, risking a flatlining of the global economy – and leading to anL-shaped’ stagnant growth scenario (or depression), but some have argued that the current lack of transparency around the duration of lockdowns and the timescale for bringing economies back online, could dent economic resilience and force more lasting, structural changes if a ‘lockdown for longer’ approach is adopted, or a premature ‘lockdown lift’ fails to stem the spread of the virus and leads to further clamp downs.

When looking to gauge the nature and trajectory of the global recovery, there are no clear signposts, but some researchers are looking to China for guidance on the prospects for other regions, once lockdowns begin to lift.

China’s economy is currently estimated to be operating at around 80% of capacity1. Certainly on the supply side, China has been able to open factories again and ramp up manufacturing (Official manufacturing PMI was 50.8 in April), but order books may remain thin and supply chains could still be compromised as other countries struggle to catch up. Retailers are reopening across many cities, but domestic demand is yet to pick up meaningfully; retail sales remain weak, and many people are still only venturing out for essentials. The Chinese authorities have rolled out a spate of policy measures more recently to get the economy back up and running at full capacity, with a particular focus on reviving consumer demand. Other regions may well look at progress here as a barometer for likely demand pick up in the wider global economy as restrictions begin to be relaxed.

However, at the same time as the authorities are pushing to get back to ‘business as usual’, China is also battling a second wave of infections, with a concentrated outbreak in the north-eastern city of Suifenhe due to Chinese nationals coming across from Russia. Returning to some semblance of economic normality while preventing another infection spike will be a delicate balancing act that other countries and regions will be closely monitoring.

Latest economic data from the US has come in worse than feared. US GDP fell at an annualised rate of 4.8% in the first three months of the year, the fastest quarterly contraction since 20082. Personal consumption, the biggest driver of US economic growth, was down (-7.6%), which marked the biggest decline since 1980. Perhaps unexpectedly, healthcare accounted for around 40% of the fall in consumption (with lucrative elective surgeries being cancelled or postponed), while transportation, recreation, food services and accommodation also experienced sharp declines.

More broadly, pent-up consumer demand may still be there but the prospects of this being unleashed in the near term may be less certain than suggested by some more optimistic forecasts, and the pain for retailers, restaurants, airlines, leisure, and travel & tourism companies in particular, could be more prolonged than many had thought.

A recent study by Jefferies Global Research found that only 1 in 5 consumers plan to go shopping as soon as restrictions are lifted, and most are not even planning to book holidays for 2021.

The services sector has taken a much greater hit during the COVID-19 crisis than has typically been the case in past downturns, and it is the largest contributor to global GDP.

For a recovery to take hold, we will need to see a meaningful ramp up in service sector activity. Countries that have taken swift action and avoided imposing severe restrictions, such as Taiwan, or appear to have effectively contained the virus, as is the case of China, are in the best position for an early recovery in services activity. We have already seen the green shoots of this in China, with retailers reopening their doors in most cities and 98% of large companies resuming operations. The Caixin China General Services PMI rose to 43.0 in March 2020 from a record low of 26.5 in February3.

Where lockdowns and restrictions remain in place (particularly across the developed world, which has become the epicentre of the virus) policymakers’ effectiveness in reigniting output and demand in a steady and sustainable way when these restrictions begin to lift, will be key to maintaining the global recovery.

How much pain is being priced in?

The magnitude and speed of the collapse in activity globally is unlike anything we’ve experienced. With lockdowns across developed markets only beginning in earnest in March, and unemployment claims still on the rise, the second quarter is likely to deliver a much bigger shock to GDP figures in the US and Europe. Similarly, while businesses have been quick to sign up for grant and loan assistance, given the lack of clarity for many we may be yet to see the full impact of the crisis being priced into earnings revisions for 2020 and beyond. First-quarter earnings results are filtering in and, while less than half of companies have reported, results so far point to negative earnings surprises in the US and Europe – with cyclicals, consumer sectors, commodities, and financials having a particularly bad quarter. Consensus expectation are for a 15% drop in earnings in 2020 (down from +9% expected in January), with a recovery of +23% in 2021, up from around 10% in January this year4. Currently, and assuming containment measures prevent further widespread outbreaks, the IMF expects the global economy to contract sharply by (-3%) in 2020, and recover in 2021, growing 5.8% with the tailwind of fiscal and monetary policy support.

Still some way to go

The response to the crisis, while global in scale, has been more fragmented than some had hoped, with countries and regions responding to varying degrees after the discovery of the first local cases. Many have been accused of being slow to act to combat the ensuing health crisis.

In all responses, public policy has been driven by a desire to avoid worst-case outcomes, and to ‘flatten the curve’ (avoiding a concentrated spike in cases that has the potential to overwhelm healthcare services).

The good news is that the lockdowns and social distancing controls look to be working. China, having reported the first cases, has emerging ahead of other countries in containing the outbreak and reigniting its economy, while most other countries that have imposed restrictions look to be at peak or near-peak contagion rates.

The less good news is that the ‘exit strategies’ for many countries remain outlines at best. In the face of so many unknowns, the journey ahead may be long, and economic activity could remain at levels significantly below normal for some time to come.

Future shape-shifting

Given the sheer volume of fiscal and monetary stimulus launched at this crisis from across the globe, the bulls may yet prevail and see a ‘V-shaped’ recovery come to pass. Equity investors look to be focusing on the medium-term and hoping that the scale of the global stimulus will prop up companies through the second half of the year, and deliver stronger-than-expected economic growth and corporate profits from 2021 onwards. This optimism was reflected in the rebound in April, with global equities retracing some of the lost ground in February and March.

It’s possible that, as we move through earnings season, further negative earnings surprises might challenge this bullish sentiment. Crucially though, any such bullish scenario will depend on government and central bank stimulus measures working efficiently and being implemented without great delay.

A ‘V-shaped’ recovery assumes a relatively swift return to normality after the lockdowns are lifted, and output lost in the downturn being fully recouped during the rebound – with supply chains ticking over as before (or quickly adapting), consumers returning to old habits shortly after restrictions are lifted, and employees being ready and able to return to work to provide products and services.

Yet, despite the enormous amounts of fiscal and monetary stimulus being injected into the global economy, there is substantial uncertainty about the future viability of large swathes of the corporate world, as industries-at-large come under huge amounts of pressure to stay afloat during a very unique crisis with an undefined solution and an uncertain exit strategy.

There is the potential for some of the fastest-growing industries such as tourism, hospitality and airlines/aerospace to suffer longer-term, structural damage. If the recession inflicts this longer-term damage to corporate balance sheets and/or labour markets, then a drawn out ‘U-shaped’ recovery is a distinct possibility.

The danger of a ‘W-shaped’ recovery is also not altogether unlikely. With recent investor optimism seeing markets retrace a good portion of this years’ losses, valuations could be vulnerable to repricing. While historic data supports the case for up markets (having retraced most of their losses) continuing on the same trajectory, the experience after the Great Depression may give pause for thought. After the crash of 1929, the US stock market rallied more than 40% from its November 1929 low through the first quarter of 1930, before sliding another 80%. It did not reclaim its 1929 highs until September 1954 – 25 years post the crash5. For the bulls, this may seem an unlikely scenario now, but it is not out of the realms of possibility.

The removal of restrictions will likely be gradual to avoid the health and economic risks of a second large spike in infections. Singapore, having had some early success, is seeing a resurgence in virus cases, as are parts of China as mentioned earlier. Certainly for developed markets, the move out of restrictive measures could be one of trial-and-error rather than along a defined path. Still, until a vaccine or effective treatment becomes widely available, economies may tentatively return to operations but ‘business as usual’ could be some way off. Time will tell how we emerge from this crisis, and when the time comes, hindsight will inevitably play its role.


1 https://triviumchina.com/2020/03/07/coronavirus-getting-china-back-to-work/

2 https://www.ft.com/content/06493320-083a-4a7d-94cc-8db581f9ed03

3 https://tradingeconomics.com/china/services-pmi

4 Source: JPMorgan, IBES, 29 April 2020

5 https://www.ft.com/content/10d24f35-dee9-4991-a7bd-51be9097a100


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