Shamik Dhar argues that the coronavirus pandemic has the potential to accelerate the long-term secular trends driving markets.
Investors are currently faced with an unusual conjuncture of circumstances. Stark economic statistics reported over the past three weeks, including a major unemployment rise in the US and a sharp fall in China's GDP, highlights the extent of the economic impact induced by covid-19.
Contrastingly, global stock markets have been reasonably strong since 23 March, rising approximately 25% globally, despite this period of increased volatility.
The course of the economy in the second half of the year and into 2021 will fundamentally depend on the course the disease takes - and that remains highly uncertain."
There are three drivers behind this trend. First, this economic shutdown has been discounted for quite some time, with market participants anticipating that a global lockdown would result in a significant impact on GDP levels throughout 2H2020.
Second, stock markets are taking heart from infection curve flattenings, with markets working on the assumption that we are past the peak in a number of major countries. Third, and arguably most importantly, markets are holding up rather well thanks to the size of monetary and fiscal stimulus being injected into the economy and markets.
Outlook for 2H2020
The course of the economy in the second half of the year and into 2021 will fundamentally depend on the course the disease takes - and that remains highly uncertain. The outcome markets seem to be pricing in at the moment is a V-shaped recovery. On the other hand, should a second wave of cases emerge, or if country lockdowns are extended, a U-shaped or W-shaped recovery could emerge.
If the lockdown persists, or if we see a fresh bout of market turmoil, then an L-shaped scenario is most likely. All in all, BNY Mellon attributes a 35% chance to a U-shaped recovery; 35% to a V-shaped recovery and 20% to an L-shaped recovery."
Outlook for oil
To some extent, the WTI oil price falling into negative territory earlier this week was just a peculiarity of the contract delivery of West Texas Intermediate and the storage facilities in Cushing. For example, we did not see the same with Brent which settles in cash. Prices have recovered a bit since the May contract expired, but there remains a fundamental issue with the supply-demand imbalance. Demand has collapsed and although there have been output cutbacks, these have not been sufficient to prevent stocks building up, as seen in Cushing.
This is likely to continue for some time, leading to a change in shape of the WTI futures curve, with the front-end contract being significantly underbid. The fundamentals of the oil market remain driven by the supply-demand imbalance, and if this is not corrected, we are likely to see oil prices remain low for an extended period.
Longer-term secular trends
The appearance of covid-19 has threatened to accelerate the four long-term, secular trends driving markets: deglobalisation, geopolitical fracturing, automation and decarbonisation.
In terms of deglobalisation, supply chains are significantly impacted and are likely to shrink quite dramatically following the crisis. While the WHO recently called for the de-politicisation of the coronavirus, it nonetheless marks the beginning of a real sea change in the relationship between the US and China. The collapse in oil prices also has the potential to create political fault lines with huge implications for major exporting countries such as Saudi Arabia and Russia.
Furthermore, there will be an accelerated move towards automation to keep the cost increase of shrinking supply chains and localisation down to a minimum. With restrictions on travel, carbon emissions are likely to fall by approximately 20 per cent this year. Off the back of this, governments and companies may consider accelerating their decarbonisation plans.
Shamik Dhar is chief economist at BNY Mellon Investment Management.