Phased pandemic recovery contains multiple risks

The economic recovery from Covid-19 will come in three phases, a report from Manulife Investment Management says, with the rapid rebound stalling out in September, and a de-globalized “new normal” emerging in a couple of years.

Economists have cycled through various letters in recovery forecasts, from the optimistic V to the downbeat L. In Manulife’s outlook for the second half of 2020,  global chief economist Frances Donald said it’s time to move away from the alphabet when characterizing the risks and opportunities ahead.

The “rapid rebound” phase, which began in mid-April, may look like a V, with manufacturing recovering quickly and purchasing managers indexes reaching expansionary levels again.

But this narrative undervalues the role of fiscal policies, Donald wrote. In the U.S., for example, household income actually rose in April by about $2 trillion because of government transfers.

“These federal transfers, along with reasonably resilient consumer confidence about the future, have gone a long way to cushioning the impact of the rising level of unemployment,” the report said.

The “stall-out” phase, which could begin as early as August and continue to the end of 2021, coincides with the waning of fiscal measures and the end of deferred mortgage and credit payments. Unemployment will weigh on consumer confidence, the report said, and corporate defaults could rise even with accommodative monetary policy remaining in place.

“Crucially, the risks that seemed to have dissipated during the first phase of the recovery could not only re-emerge, but become amplified during this stall-out phase,” the report said.

Finally, a “new normal” will emerge in 2022, characterized by “de-globalization, potential changes to tax structures, and a frantic search for yield,” the report said.

Companies developing domestic supply chains could contribute to “moderate” inflation, while countries waking up to “possibly the worst ever” fiscal situations may face calls for both austerity and redistributive tax policies, Donald wrote.

In its mid-year outlook report, Vanguard Investments Canada forecasted a strong V-shaped recovery in the third quarter followed by “a more prolonged U shape,” with reluctant consumers shying away from face-to-face contact.

Annual global GDP will shrink by 3% in 2020, the largest contraction outside wartime, and Canada’s GDP will be 6% lower than last year. “We do not expect the global GDP to recover to its more normal pre-virus trajectory until late next year,” the report said.

Vanguard said further fiscal support is likely in the face of a “sluggish recovery,” with little political pressure for austerity in the near term.

“Rising inequality could be aggravated, with the disadvantaged in society tending to be the most badly affected,” the report said. “Whether this strengthens or undermines the tendency toward populist politics remains to be seen.”

Vanguard’s baseline forecast (50% probability) is for a gradual return to work, with local lockdowns responding to “isolated pockets of renewed spread in the virus” and a vaccine available by the end of 2021.

The upside scenario (15% probability) has a vaccine available sooner, but the asset manager’s downside scenario (35% probability) features renewed Covid-19 spread and broader shutdowns that “prevent a meaningful recovery in global GDP for much of this year and next.”

What this means for investors

The fall in global equities this year means improved valuations, Vanguard said, creating an opportunity for higher returns — an average of 5% to 7% for both Canadian and global equities this year. Fixed-income investors, on the other hand, should expect returns between 0.5% and 1.5%, the report said.

“Considerable uncertainty remains, with the possibility of further market corrections ever-present,” Vanguard said. “We advise investors to focus on long-run expected returns and avoid the temptation to time such turbulent markets.”

The Manulife report said the “risk-on mentality” since equities bottomed out in March may shift to an emphasis on quality assets during the “stall-out” phase of recovery. Gold could also do well over the coming year.

The “search for yield” will increase after next year, “a development that could push investors further out on the risk spectrum, swapping traditional government bonds for higher-yielding alternative assets,” the report said.