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COVID-19 & The Economy

Updated: Jun 7, 2020

When Covid-19 made headlines in Wuhan, China, the expectations for the global economy were very optimistic. Even after China reporting thousands of cases, investors and economists around the world expected the spread of the virus to be contained within the borders of China, limiting the adverse impact on the global economy. However, as we now know, things got out of control in a whisk, and the United States has now become the epicenter of the virus. The expectations for economic growth are now bleak for the remainder of the year as well. However, a few silver linings have emerged amid the dark clouds.

The global economy will contract at a record pace but there’s hope for 2021

Since the fallout of the financial crisis, the global economy has expanded at a stellar rate. Both developed and developing regions enjoyed favorable macro-economic conditions, which in return helped them grow. However, Covid-19 has suddenly brought global growth to a standstill. According to the projections by the International Monetary Fund, the global economy will contract by 3.8% in 2020, marking the worst year in more than 3 decades.

Source: Bloomberg

Even though the outlook for 2020 is disappointing, investors can be hopeful of a historic recovery in 2021. IMF projects the global economy to expand by a staggering 5.8% in 2021, which would be the highest annual growth since 1980. This expectation is based on the assumption that mobility restrictions imposed by governments across the world will be lifted by the second half of this year, leading to a resumption in global manufacturing activities. The trillion-dollar stimulus packages introduced by state governments will also play a critical role in this expected growth in 2021.

The U.S. economy is hit hard

Covid-19 has wreaked havoc in the United States. Business activities have come to an abrupt stop, and the U.S. economy contracted by an eye-popping 4.8% in the first quarter of the year, highlighting the negative impact caused by the virus.

Source: The Independent

The negative growth in real GDP did not come as a surprise. What is more alarming is that the second-quarter numbers might look even worse, because America went into lockdown in the last couple of weeks of March. The month of April has been a disaster for many businesses that depend on foot traffic to their brick-and-mortar stores, and this will be reflected in the second-quarter GDP growth numbers.

Even though the country is planning a reopening, there is a lot of uncertainty regarding how consumers will react. For instance, in China, even after the restrictions were eased in the first week of April, business activities have remained lackluster as many Chinese residents have opted to stay inside in fear of a second wave of Covid-19 infections. Empirical evidence suggests that such waves could often prove to be disastrous. For instance, the second wave of the Spanish Flu pandemic in 1918 killed millions of people in the United States.

In the United States, things could prove to be similar to that of China. If this happens, it would be reasonable to assume that the second-quarter numbers will be another disappointment.

The path to recovery will be bumpy. Not every company will recover at the same pace

The United States has survived adverse economic conditions in the past and eventually emerged out of those troubles. There’s no reason to believe that things will be any different this time around. However, the path to recovery will most likely be very bumpy. Not every company is created equal, and the next few months will prove this.

Business sectors that depend on public gatherings such as restaurants will find it difficult to get back to their normalcy anytime soon. True, food delivery and drive-through sales will see an uptick but dine-in sales will likely remain under pressure even after mobility restrictions are lifted. The state governments are likely to impose restrictions on the maximum capacity allowed at restaurants and bars, the same way China and the United Arab Emirates has done so far. The same is true for theme parks as well. Therefore, companies representing these industries will operate below their maximum capacity, leading to a massive loss of revenue.

Online-oriented business sectors, however, will report stellar growth in the coming months. People who are confined indoors are increasingly subscribing to Netflix and other over-the-top content streaming platforms, and Americans are left with no option but to order their groceries from e-commerce stores such as Amazon. As illustrated in the below chart, the usage of popular social media websites and Netflix have soared since America went into lockdown.

Source: The New York Times

The stay-at-home economy, on the other hand, has led to an uptick in the number of companies looking for cloud storage facilities, which is a positive sign for the leaders of this industry such as Amazon and Microsoft.

Takeaway: supported by stimulus packages and Fed policies, recovery will take place by 2021

The federal government has approved trillion-dollar stimulus packages to revive business activities in the country. On the other hand, the Federal Reserve has cut the interest rates to near zero in a bid to encourage borrowing by consumers and businesses. In addition, the Fed is pumping liquidity into the market by buying billions of dollars worth treasury securities. All these measures, combined with the expectation for easing mobility restrictions in the next few months, will lead to a spectacular recovery of the American economy. However, this does not mean that every company will survive. According to data from Bloomberg, a record number of small companies went bankrupt during the financial crisis of 2008, and a similar phenomenon is expected this time around as well.

For investors, the key is to identify resilient business models that have what it takes to survive the pandemic and come out stronger. Special attention should be given to companies that are cash-rich and/or have very low levels of debt. These companies have the upper hand over their peers in poor financial health to survive this crisis and grow in the coming months. Equity markets will be very volatile until the spread of Covid-19 is curbed, which could be as long as two months away, going by the projections of the World Health Organization. Investors can turn this volatility into opportunity by betting on companies that are benefiting from the lockdown.

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