Economic development in a country is best measured by GDP and GDP expectations. Given that share prices reflect expectations on the future stream of earnings, economic expectations are a key driver to the outlook. Following the start of the covid-19 pandemic, and the consequent lockdown period, economic expectations have turned negative for 2020. Nevertheless, the focus has shifted on the recovery beyond the short-term decline, and whether economies will bounce back as easily as expected.
On June 24, the International Monetary Fund (IMF) issued its warning that economic expectations are now worse than initially anticipated, and downgraded its outlook from April by another 1.9 per cent to a global growth decline of 4.9 per cent in 2020. Despite forecasting a 5.4 per cent increase in global growth in 2021, the IMF remarked that the 2021 GDP level is still expected to remain significantly lower than pre-COVID-19 levels.
Relative to the US, Europe suffered a larger downgrade to the economic outlook, with the IMF forecasted output to decline by 10.2 per cent in Europe compared to eight per cent in the US. Within the region, the fund slashed the forecasted decline for France, lowering the expected economic decline to 12.5 per cent, similar to Italy and Spain.
Despite that some economies have achieved declining infection rates, the IMF quoted that the persistence of social distancing measures, greater damage to supply potential and a decline in productivity despite remain headwinds to economic growth and paves the way for a slower recovery path than initially estimated.
In the long term, the drivers of economic growth and potential GDP ultimately underpin the value of equities and therefore are the same drivers for equity market returns. In fact, the long-term aspect in this equation could offer an explanation to the current disconnect between financial markets sentiment and the expected decline in GDP growth in the short term.
Meanwhile, economic data since the reopening still presents mixed signals. In the US, manufacturing PMI rose to 49.6 in June, beating expectations. Even so, the below 50 reading represents a period of contraction in the overall economy. Moreover, the number of US citizens filing for unemployment benefits came in above expectations, despite slowing down to 1.48 million in the week ending June 20. Moreover, due to a decline in government social benefits, personal income in the US declined month-on-month, raising the question whether fiscal benefits will be renewed beyond July.
In Europe, PMI data points to a more positive direction with Eurozone PMIs beating expectations as Germany and France PMI readings came in better than expected. France even managed to record the first expansion in the private sector, with Composite PMI reading of 51.3 for the month of June. However, the COVID-19 pandemic created both supply and demand disruptions which has triggered a surge in demand for funding. Loans to companies in the euro area expanded by 7.3 per cent in May, continuing to increase on a monthly basis as companies aimed to boost their liquidity and ensure funding during this crisis.
Despite that the economic reopening seems to be on track, the potential rise in COVID-19 cases and the risk of renewed lockdowns still remains high. The increase in daily COVID-19 cases and the reduction of hospital capacity in the US is once again reigniting concerns. Case in point governors in Texas and Florida have decided to halt the reopening by introducing new measures on restaurants and bars. While different methods can be implemented to contain the spread of COVID-19, any form of measure to slow or halt the economic reopening could hinder economic recovery.
Disclaimer: This article was issued by Rachel Meilak, CFA equity analyst at Calamatta Cuschieri. For more information visit www.cc.com.mt. The information, view and opinions provided in this article are being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice.