I’d like you to take away three key points from today’s conversation. One, we’re entering a sharp global recession. Two, policymakers are responding rapidly with forceful measures to try to prevent this sudden stop in economic activity and its resulting liquidity crisis from turning into a solvency crisis. And three, I think the authorities are only going to be partially successful at this and the recovery is likely to be weaker than many people think.
Entering a Sharp Global Recession
I think many of you are aware that the economic hit from Covid-19 and the measures to contain the virus’ spread are going to be massive. We expect to see largest quarterly economic contractions of the post-World War II period. Slide 2 shows the manufacturing and service sector PMIs for the major advanced economies and the emerging markets. PMIs are diffusion indexes, measuring whether sentiment is better, worse or the same as the previous month. As you can see, service-sector PMIs collapsed and are now the weakest in the series’ history, which reflects the sudden stop in service-sector activity as we’ve moved to social distancing. On the manufacturing side, PMIs haven’t fallen as dramatically; this reflects that supplier delivery times, which is one component of the manufacturing PMI, have lengthened. Usually, lengthening in supplier delivery times is a good thing because it reflects strong demand, but in this case it reflects supply-chain disruption. So my expectation is these manufacturing PMIs will decline from here.
PMIs are useful data points because they’re the first monthly data that’s released, they’re forward-looking and they correlate with GDP. But they really don’t do a good job of illustrating the depth of contraction; they really just measure change. For instance, while China’s PMIs came in above the 50 mark in April, suggesting expansion, this doesn’t necessarily mean that conditions are good; it simply means that more firms saw an improving outlook compared to March.
One of the challenges facing the US economy is high income inequality, as 90% of US households are income-constrained. This means that their net savings rates are negative and thus they are dependent on their paychecks to make ends meet. So, the US economy, which is overwhelmingly driven by consumption and service-sector activity, is vulnerable to workers losing jobs. Unfortunately, as I’m sure you have seen, initial unemployment claims came in at 10 million for the two weeks ended March 28. This is going to be a huge blow to the US economy.
Slide 4 shows our forecast for growth across the G7 and the BRICs, presented in two ways. The left chart depicts real GDP growth on a quarter-on-quarter, seasonally adjusted annualized rate, while the right chart shows the same real GDP, but in level terms. It’s a little complicated, so I’ll explain.
The forecast for 2020 and 2021 are those of the First Eagle Global Value team. I think it’s very important to be humble about the forecast. We’ve never seen an event like this before. And in addition to all the uncertainty on the economic side, there’s so much we don’t know about the virus, let alone how the economy is going to respond to social distancing and the eventual removal of these policies. One of the key uncertainties is whether we will have a second wave of this virus. As people go back to work, are there new infections, and does that necessitate another shutdown of the economy? Our forecasts assume that this doesn’t occur, though many respected epidemiologists believe that it’s a strong possibility. One of the things we’re watching is what happens as China and other Asian economies relax social distancing and go back to work: Do we see renewed cases? This will be one of our key watch points going forward.
Continue reading with original slides here.
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