HOW DOES COVID-19 COMPARE TO THE GFC?
COVID-19 came out of nowhere, causing significant economic upheaval and breaking an incredible streak in markets. Markets fell to a degree not seen since the global financial crisis (GFC) as investors tried to work out how severe the impact would be on the global economy.
COVID-19 caused a very large market correction
This sharp shock has, of course, caused many to draw parallels to the GFC, and there is no doubt we are enduring challenging times. But, to what extent is this similar to that experience just over a decade ago, and how is it different? Let’s not sugar-coat it, physical distancing and the closing of borders have disrupted our day-to-day lives to an extent we’ve never seen.
The Reserve Bank of New Zealand estimates that the Level 4 lockdown will have lowered economic output by 37 per cent, Level 3 by 19 per cent, and Level 2 by 8.8 per cent. For the year, gross domestic product will fall substantially. The Treasury recently published a scenario analysis showing that in the best-case scenario, with the Government providing even further stimulus, GDP for 2020 would be down 4.5 per cent before rebounding in 2022. In this scenario, the unemployment rate would still reach 8.5 per cent, something we haven’t seen since the early 1990s.
The GFC was a different type of event
These best-case scenarios look immediately worse than what we saw through the GFC, where unemployment peaked at 6.7 per cent and GDP fell by 2.3 per cent.
However, the GFC posed a threat to the makeup of our entire financial system and was in many ways much scarier. Following the failure of several high-profile offshore banks, uncertainty reigned for an extended period and very few companies escaped the wrath of the market. The NZX 50 peaked in early 2007 and didn’t trough until 2009, almost two years later. The lowest recorded growth rate in GDP actually occurred in 2011. It was death by a thousand cuts as compared to the one sharp blow delivered by COVID-19.
Looking at the present situation, after a troubled period in credit markets, things look to have stabilised with central banks moving quickly to inject vast amounts of liquidity into the system and governments opening their chequebooks – no doubt guided by their experience through the GFC. 2020 saw the fastest 20 per cent sell-off (the common qualifier for a ‘bear’ market), in history. Even while economic data gets worse and worse, markets have subsequently rallied strongly with April being the best month for the S&P 500 since 1987.
With case rates showing improving trends across a number of countries, investors are increasingly looking for the light at the end of the tunnel and a return to more normal economic activity. While this won’t happen overnight, or even when we get a vaccine, it feels like a more finite event with several countries around the world beginning to loosen restrictions. This may seem strange but keep in mind that sharemarkets look forward and typically move well before economic indicators do.
COVID-19 caused a sell-off of unprecedented speed
Our banks are also more resilient than they were during the GFC, with regulators mandating capital positions be substantially beefed up over recent years. The four major Australian banks, which own the big four New Zealand banks, entered this period with roughly twice the amount of capital compared to 2007, and sit in the top quartile globally. This will enable them to absorb a sharp spike in bad debts, support borrowers and keep credit-lines open.
It’s also worth keeping in mind that while March saw a scary few weeks of broad-based selling and fear, the wrath of the market has largely focused on those experiencing a sharp demand or supply shock. Companies immune to the effects of COVID-19, not to mention those that have benefitted, have fared well.
A quick look at the New Zealand market proves this point. Some of our largest companies, for example, Fisher & Paykel Healthcare, a2 Milk and Spark have held up well this year. However, those with earnings exposed to COVID-19, such as Auckland Airport, Sky City and Air New Zealand have seen their share prices hit much more. A similar story holds across other key global markets.
Not out of the woods just yet
The economic numbers and corporate profits ahead won’t be pretty and it will get harder and harder for investors to look through this, try as they might.
Even when we get back to normal, the effects of COVID-19 will linger for a long time. Central banks have thrown the kitchen sink at this. The Reserve Bank of New Zealand has embarked on a very large quantitative easing (bond buying) programme, something that seemed unthinkable even a year ago. Similar programmes the world-over have been extended, and their targets expanded into new assets. Central banks have effectively fired all the bullets they had – what will they do next time? We may have entered a new monetary paradigm.
In addition, the strong fiscal response we’ve seen, and associated drop in tax revenue, will increase government debt levels globally. There are no free lunches, and higher debt levels will weigh on economic growth in the years ahead. Fortunately, many years of good discipline mean the New Zealand Government went into this with a very healthy balance sheet, leaving us better placed than most.
There will also be a number of structural changes to bear in mind. What does COVID-19 mean for globalisation? How does it change the way we work and shop? Do the stronger companies get even stronger? Do we finally see high levels of inflation down the track?
COVID-19 will be a defining event for years to come and the economic fallout won’t be pretty. But with swift action from central banks and governments, we’ve hopefully avoided another GFC-type event.
Just remember, while scary, downturns present opportunities
In the end, while experiences like the present can be uncomfortable, the flipside is that they present a chance to buy high quality companies at a discount. It is natural for markets to fall from time to time, and while markets have recovered for the time being, they may fall again in the near future. If you’re a long-term investor, you should look at periods like this as an opportunity; why only buy companies when they are trading at record highs?