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Covid-19, the share rebound and the hit to GDP

Lex Hall  |  13 May 2020Text size  Decrease  Increase  |  
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The covid-19 recession will hurt in the short term, but it won’t have the lasting effect of the downturn wrought by the Depression or the 2008 global financial crisis, says Morningstar.

The long-term hit to US and global GDP will be -1 per cent, says Morningstar head of economics Preston Caldwell, in a new report that compares the current crisis to the Great Depression and the GFC.

As recession grips the US and global economies, Caldwell had updated his forecasts and now expects global GDP to fall by 2.4 per cent in 2020, up from a previous forecast of 2 per cent.

He expects US GDP to fall by 3.9 per cent in 2020. US growth averaged 4.1 per cent in the 1950s and 1960s but then slowed to 3.3 per cent over the 1970s through the 1990s. Growth then slowed to 2 per cover the 2000s and 2010s.

GDP impact is the most important question for investors

Long-run GDP impact is the most important question for investors

Source: Morningstar

The key question for investors, Caldwell says, is not what happens in 2020 but what happens in the recovery. Caldwell examined 191 recessions occurring in a sample of 48 countries from 1950 to 2017. His study finds 16 per cent of cases end up at or above the pre-recession trend by year 5 after the recession.  

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“The impact of covid-19 and the recession on long-run GDP is key to understanding whether the recent rebound in equity prices makes sense,” he says, referring the bounce in share market prices since 23 March when lockdown measures took effect.

“Our analysis shows that many recessions don't have a long-run impact on the economy. The worst recessions in terms of long-run impact (the Great Depression or the Great Recession) are generally the product of persistent economic policy error.”

The US and global economies didn't collapse into the Great Depression overnight, Caldwell says. Instead, they worsened over a four-year period as central banks responded to a burgeoning financial crisis in the worst possible way: by contracting the supply of money. They did so because of a misguided commitment to the gold standard.”

Great Depression was a product of persistent policy error

Great Depression was a product of persistent policy error

Source: Maddison Project Database, Morningstar

Despite unemployment rates of 15 per cent in the US, Caldwell says the policy response from governments, including historically large fiscal stimulus measures has been “extremely impressive”.

The US has responded to surging economic pressures from COVID-19 with a US$2 trillion stimulus bill (about 10 per cent of US 2019 GDP). The stimulus will add about US$1.6 trillion to the US budget deficit (8 per cent of GDP) in 2020.

“Many recessions historically haven't been like 2008 and instead have had a very robust recovery. In some cases, recessions appear to have zero negative impact on long-run GDP growth.

“There's good reason to think that the COVID-19 recession won't resemble recessions like 2008, which had a large long-run impact on GDP. As such, we forecast just a 1 per cent impact on the long-run level of GDP for both the US and the world.”

2008 Lehman Brothers collapse turned a housing bust into a great recession

Lehman collapse turned a housing bust into a great recession

Source: US Bureau of Economic Analysis, Morningstar

Impact on share prices

Using a discounted cash flow model, Caldwell says the 1 per cent hit to long-run US and global GDP translates to a 2 per cent hit of equity fair value (relative to a pre-covid-19) forecast.

“Adopting a scenario in which near-term GDP impact is much worse (but long-run impact is the same) has little impact on the fair value hit.

“By contrast, assuming a long-run impact of 10 per cent—on par with the Great Recession (GFC)—has a major impact on equity fair value.”

Nor does Caldwell see the covid-19 causing a supply-side shock and says policymakers can stimulate demand through fiscal measures.

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is senior editor for Morningstar Australia

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