Social distancing is the hallway for economic recovery
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- By Ken Howard
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- 27 April 2020, 12:00 PM
I feel I need to write a note about the dichotomy that is unfolding in health (Australian versus North America and Europe), the economy (Australian versus North America and Europe) and the share market (health & technology versus banks, property and oil).
Health
It is my guess, that Australia and New Zealand are amongst only a handful of countries, who can potentially contain the virus in the next four to six weeks and allow their domestic economies (that is locals serving locals – international tourism is still many months way) to begin the recovery.
I have listed below half a dozen reasons why I believe the Covid-19 stats support the Government’s position, that once they have sufficient resources to; test, trace and contain the virus, they will be able to begin to relax the social distancing rules, potentially from Monday 11 May.
For Australia
- The number of active cases (active = total cases less recovered cases less deaths) peaked on 4 April and has been declining everyday, for almost three weeks.
- Close to 65% of Australians who have contracted the virus have recovered and less than 2% have died.
- Around 75% of the remaining active cases (or 26% of all confirmed cases), have had the virus for at least two weeks and are very likely to recover in the next two weeks. In fact, there is a real chance the number of active cases in Australia will be less than 500 (currently 2345) by 11 May.
- Encouragingly, only 2% of current active cases are in ICU (intensive care units).
- Over the last five days, Australia has completed over 60,000 tests and detected 177 new cases. In other words, fewer than 0.5% of tests are positive (99.5% of tests are negative), which gives me considerable confidence (when combined with the very low mortality rate) that the community tracing is expansive and effective.
- Of the 177 new cases, fewer than 10 are under investigation, which means most of the new cases are as a result of contact with a confirmed case (e.g. the outbreak in North Western Tasmania).
So, in summary, for Australia, based on current trends, current testing and current social distancing rules, large parts of Australia will be Coronavirus “free” by Monday 11 May and may very well stay Coronavirus “free”.
To illustrate; the recovery rate in Victoria is currently over 90%, in WA & SA it is currently over 80%, in QLD it is currently over 70% and there has been no new case in NT for 14 days. But before any decision is made to relax the social distancing rules, the Government has wisely opted for a contingency plan, Australia must have sufficient resources to continue; testing, tracing and containing the virus. Fingers crossed we get there.
However, it is a very different story for the US and Europe
- The mortality rate (deaths / total closed cases) is close to 20%, in other words one in five do not recover. For the USA, as 20 April, total closed cases = 114,903, of which 72,389 had recovered and 42,514 had died. For Europe, as at 20 April, total closed cases = 426,012, of which 321,521 had recovered and 104,491 had died.
- The current level of testing is insufficient to have an effective community transmission tracing operation in place. To illustrate, as at 20 April, the USA had reported over 4 million tests and 792,759 confirmed cases, that is close to 20% of tests have been positive. To date, I haven’t found any data which breaks down the tests into e.g. tests for medical workers, tests for recovered cases, tests for those who live with or regularly visit someone who has the virus, but I suspect the number of random tests being conducted to trace community transmission is less than half of all tests.
It is for these two reasons; (a) a very high mortality rate and (b) a very high level of positive tests (so arguably a low level of tests for community tracing), that I believe that the actual undetected level of coronavirus in the USA and Europe (and probably most parts of the world) is potentially five times higher than is being officially detected and recorded.
So what does that mean for the USA and Europe (and large parts of the rest of the world)?
Well according to this poster, published by the Australian Government, social distancing will reduce the rate at which the virus spreads, from 22% per day (compound) to 4% per day (compound).
Europe and the USA currently each have over 650,000 confirmed active cases. If I assume that there are three times as many undetected cases as confirmed cases and that social distancing will remain in place (at the 75% less exposure level), then mathematically, within four months, everyone in the USA and Europe will have contracted the virus.
However, in reality, 100% infection is extremely unlikely, what is more likely is that within the next couple of months, the USA and Europe will achieve some form of herd immunity and the spread of the virus will slow materially and provide their governments with the opportunity to begin relaxing the social distancing laws.
I am not a fan of “herd immunity” as a strategy, as it comes with a potentially lethal price for hundreds of thousands of elderly, but it will stop the spread of the virus.
In theory, somewhere around a 50% infection rate, the virus stops spreading (or at least it becomes a lot easier to contain), if only because most of the people it comes in contact with, either already have the virus, or have recovered and have “immunity”.
The economy
Precision in economic forecasting is impossible, however being roughly right is possible, given a good dose of experience, common sense and lateral thinking.
On 21 April, the Governor of the Reserve Bank of Australia, Dr Philip Lowe, outlined his views on the immediate economic outlook and the nature and speed of the recovery:
- “National output is likely to fall by around 10% over the first half of 2020, with most of this decline taking place in the June quarter*” (*1 April to 30 June).
- “Total hours worked in Australia is likely to decline by around 20% over the first-half*” (*1 January to 30 June).
- “The unemployment rate is likely to be around 10% by June, although I am hopeful, that it might be lower if businesses are able to retain their employees on lower hours. The unemployment rate would have been much higher than this without the government’s JobKeeper wage subsidy”.
The Governor also made the following observations which I would like to repeat:
- “As Australians digest this economic news, I would ask that we keep in mind that this period will pass, and that a bridge has been built to get us to the other side. That bridge has been partly built with the help of Australia’s strong balance sheets – in particular, the strong balance sheets of our governments, our private banks* and of the Reserve Bank.”
(asterisk added, *e.g. ANZ, CBA, NAB and Westpac)
- “We can be confident that our economy will bounce back and that we will see it recover. We need to remember that once the virus is satisfactorily contained, all those factors that have made Australia such a successful and prosperous country will still be there.”
- “One plausible scenario is that the various restrictions begin to be progressively lessened as we get closer to the middle of the year, and are mostly removed by late in the year, except perhaps the restrictions on international travel. Under this scenario we could expect the economy to begin its bounce-back in the September quarter and for that bounce-back to strengthen from there. If this is how things play out, the economy could be expected to grow very strongly next year, with GDP growth of perhaps 6-7 per cent, after a fall of around 6 per cent this year. There is quite a lot of uncertainty around the numbers, with the exact profile of the recovery depending, not only upon when the restrictions are lifted, but also on the resolution of the uncertainty that people feel about the future.”
“Of course, there are other scenarios as well. On the optimistic side, the restrictions could be lifted more quickly, with the virus being contained. In that case, a stronger recovery could be expected, particularly in light of the very large monetary and fiscal support that is in place. On the other hand, if the restrictions stay in place longer, or they have to be reimposed, the recovery will be delayed and interrupted. In that case, the loss of income and jobs would be even more pronounced.”
- “A strong focus on making Australia a great place for businesses to expand, invest, innovate and hire people is the best way of extending the recovery into a new period of strong and sustainable growth and rising living standards for all Australians.”
To summarise the above comments
If the Australian Government can amass the resources to; test, trace and contain the virus (and I am assuming this will require a “mobile phone app to be adopted and activated by the vast majority of Australians), then the economic recovery can begin on 11 May, and there is a possibility that much of the damage done by “social distancing” can be undone by this time next year (as opposed to the damage done by the cancellation of international flights, which may take a further year or two to heal).
The outlook for the USA and Europe is not dissimilar to Australia, but it is likely to come under very different conditions. If, as I am guessing, the USA and Europe are on the herd immunity path, then sometime in the next couple of months they will be able to lift the social distancing measures in communities which have been hardest hit by the virus (that is communities with the highest infection rates).
The bridge to their recovery will also be different, given a very different; balance sheet, economic mix and social impact from the virus, but just like the climb out of the GFC, the USA and Europe will recover.
The market
For investors watching banks, property stocks and energy companies, there is a very good chance the share price is down 30% to 50% from last year’s highs. What’s more, if you assumed that the business could return to paying the average dividend from the last five years (2014/15 to 2018/19), then current forecast dividend yield for the 2021/22 financial year (which will start in 14-months time) would be between 10% and 14%.
Not bad, if you assume, as I do, interest rates will still be close to zero. But I could put it another way, the banks, property trust and energy companies are pricing in a deep and protracted recession, where arguably, it will take a decade for dividends to return to anything like the average dividend from the last five years (not 14 months). The answer I hope will be somewhere in between, and for the sake of all those who have; lost their job, had their hours cut back, or are entering the workforce, I hope it is closer to two years then 10 years.
In contrast, the FANG (Facebook, Amazon, Netflix and Google) are collectively (combined market capitalisation) trading around all-time highs. It would appear, that for some investors, not even the possibility of a recession to rival the GFC will interrupt their growth path, in fact it has only created the opportunity for them to grow faster. Which is an interesting idea, given; Facebook and Google rely on advertising, Netflix relies on subscriptions and Amazon relies on consumption. All four have been extremely dynamic and disruptive over the last decade, but now they have scale, it will be interesting to see how they perform during an economic downturn.
They all obviously have considerable potential, but they are not risk free. In many cases, regulatory settings around competition, privacy and taxation, have been slow to evolve and have created the opportunity for “new world tech” to demolish old-world fiefdoms. And in some cases, the old-world titans are still standing and have been reshaping their business models to combat the new entrants (e.g. Disney, Walmart and Microsoft).
So, in conclusion maybe the recession won’t be as bad, or the recovery as slow, as the market is pricing in for the banks, property trust and energy companies (don’t get me wrong, I am not trying to say it will be easy or hassle free, and I am sure there will be some casualties).
Equally, maybe there will be a little more competition for the opportunities the “disruption” has created and a little less revenue to go around. To illustrate, for one of Australia’s favourite companies CSL, the management‘s update on 9 April highlighted a number of challenges; (a) with plasma collection, an essential ingredient into CSL’s life saving medicine (today’s collections underpin next year’s sales) and (b) disruption to clinical trials for their R&D pipeline (an important source of future growth).
Anyway, as always, life is complex and the devil is in the detail, so if you have any questions about your existing portfolio or potential future investments, get in touch.
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Ken Howard is a Private Client Adviser at Morgans. Ken's passion is in supporting and educating clients so they can attain and sustain financial independence.
If you would like to learn more about assessing your finances, you can contact your closest Morgans branch.
General Advice warning: This article is made without consideration of any specific client’s investment objectives, financial situation or needs. It is recommended that any persons who wish to act upon this report consult with their investment adviser before doing so. Morgans does not accept any liability for the results of any actions taken or not taken on the basis of information in this report, or for any negligent misstatements, errors or omissions.