Reflections in a time of Covid

A year on

Last Thursday marked the first anniversary of the World Health Organisation's classification of the Covid-19 outbreak as a pandemic. The lives of millions of people have since been put on hold as governments have been forced to lock down their economies in a bid to halt the spread of the disease. There have recently been some signs of improvement with the mortality rate across Europe significantly below its January peak as a result of renewed lockdown conditions and the acceleration of the vaccine rollout. However, daily case numbers are rising again in a number of continental European countries. They have almost doubled in Italy in the past three weeks, prompting the government to tighten restrictions, whilst in Germany the Robert Koch Institute for infectious diseases predicted that the number of daily reported cases could exceed the December peak by mid-April. The rate of decline in UK cases, which has been proceeding rapidly for the past two months, has recently slowed although there is insufficient evidence to know whether this marks a turnaround or is just a blip.

We have learned a lot about pandemics and how to manage them over the past year. The most important lesson is that lockdowns do work and in this regard the UK was slow off the mark in spring 2020. It is sobering to recollect that health experts were aware of the scale of the problem ahead of us. This edition of Question Time, the BBC’s weekly topical debate programme, from 12 March 2020 featured Professor John Ashton who delivered a withering critique of government policy and accurately predicted what was about to unfold. His efforts to highlight the extent of the disaster stood in stark contrast to the complacency of government ministers at the time. The fact that more than 125,000 people in Britain have died from Covid over the last year – the fifth highest total in the world – is testimony to policy failings. When normalised to account for the size of population, the UK’s mortality rate of 188 per 100,000 is the highest of any country with a population over 12 million (chart 1).

The more positive news is that the vaccination rollout appears to be a great success. Although Israel is well out front in terms of vaccinations delivered, the UK and US are gaining momentum (chart 2). It is sobering to recall that a year ago we were warned that it could take years for an effective vaccine to be developed. At that time the fastest any vaccine had previously been developed, from viral sampling to approval, was four years – for mumps in the 1960s. The vaccination process has not been without its controversies: Concerns persist about the effectiveness of the AstraZeneca vaccine with the most recent issues surrounding its potential side effects. In addition, there is a vaccine hoarding problem with the developed nations having bought a large supply of the world’s available stock, thereby leaving less for the poorer nations. Nonetheless, it is remarkable that such huge strides have been made in the space of just 12 months.

But we are not yet out of the woods. Lockdowns in some form or another are likely to remain in place well into April, which effectively means that economies in most parts of Europe will be operating under highly restricted conditions for up to one-third of the year. So long as concerns about new Covid variants remain a live issue, we cannot afford to be complacent with regard to the prospect of a further coronavirus wave.

Counting the economic cost

From an economic and market perspective it has been a wild ride. Last year saw the largest peacetime contractions in output in almost a century (more than 300 years in the UK case) and we cannot be confident about the pace of the rebound in 2021. In spring 2020 it was widely assumed that the contraction would be followed by a rapid recovery but a second wave of the pandemic has led to rather more muted hopes across Europe. That said, the OECD recently revised up its expectations for global growth in 2021 compared with last November with particularly rapid growth projected for China (7.8%) and the US (6.5%). Latest UK figures give some grounds for optimism, with GDP in January falling by only 2.9% versus expectations of something closer to 5%, and as a consequence it is likely that Q1 growth will turn out less bad than the 3.5% contraction currently pencilled in by the consensus (which will raise the annual growth rate, ceteris paribus).

The jury is still out as to the nature of the economic recovery. The economic shock has had implications for both the supply and demand side and the shape of the recovery will be determined by trends on both sides. Demand is likely to rebound fairly quickly, particularly given the extent of unanticipated household saving which is likely to be rapidly run down (chart 3). That said whilst spending on goods may pick up as the retail sector opens up, a lot of the spending on services which has not taken place over the last year will simply not be recouped. After all, we are unlikely to go on more holidays or make up for a year’s worth of foregone restaurant meals. It is for this reason that the damage to the supply side of the economy is hard to gauge. The future states of the airline and retail sectors are likely to be different to their pre-Covid form, whilst the leisure sector has taken a battering from which many establishments will find it difficult to recover. It is for this reason that I maintain the recovery may prove slower than a lot of projections currently suggest. 

Markets on edge

From a market perspective, in March 2020 we were about to step into the unknown – never in living memory had we experienced a global pandemic and equity markets quite simply collapsed in the face of unprecedented uncertainty. Following the actions of central banks to provide unlimited liquidity, the subsequent rebound took many by surprise – myself included. Indeed, we are now at the point where many investors believe the equity rally is overdone with the S&P500 closing last week at a record high – around 17% above the pre-pandemic high in February 2020, despite the economic collapse, and 76% above the low a year ago. This has occurred at the same time as fixed income markets have sold off as inflation concerns mount in the wake of the huge US stimulus package – a fiscal strategy which might have been better served had it been introduced last year.

It remains to be seen whether inflation fears will be realised. However, if inflation does pick up the fiscal stimulus is unlikely to be the only catalyst. Equally important – if not more so – are events in China where demographics mean that it will be increasingly difficult in future to generate big increases in output by increasing the labour contribution. To the extent that the quiescence of inflation over the last twenty years has had more to do with the expansion of low-cost global production capacity in emerging markets than anything that has happened in the industrialised world, events in China will be the key to markets in the years ahead.

One of the potential side effects of the Covid crisis is that it may serve to mask a number of secular trends that we initially ascribe to the events of the past year but are in reality due to other factors. This was the case following the bursting of the Japanese bubble economy in 1990 and the GFC of 2008-09 when a slowdown in population growth resulted in slower potential growth in the wake of the crisis, giving rise to a much slower recovery than anticipated. As we reflect on an unprecedented year, we have learned a lot about pandemics and how to combat them but we have a lot still to learn about the long-term effects on the economy and markets. There is a long way to go before we can contemplate a return to economic normality, and whatever the new normal is, I suspect it will not be like the old one.