Global Economic Cycles in the Shadow of Pandemics

Global Economic Cycles in the Shadow of Pandemics 

                                  - S.N. Ghatia

The whole world is passing through an era of eerie uncertainty about the future. The fear of modern demon COVID-19 has confined us within the four-walls of our homes. In our wildest imagination, we never thought of such a crippling situation. The fear of COVID-19 is a real medical possibility of getting infected with this deadly novel virus. COVID-19 being a new virus, its full contours are yet unknown, undefined and everyday new features are being added to its deadliness. So far there is no specific cure/vaccine in sight. Like the mythological demon Bhasmasur, this deadly virus merely by touch can infect any one regardless of caste, creed, religion, gender, age, occupation, authority, status etc. Even the high and mighty ones like the U.S. President and the British P.M. etc. have not been spared by the vicious demon COVID-19.

Economic activities have come to a halt world over in the wake of COVID -19 lockdown. There is a growing apprehension of worldwide economic recession. Calamities, market crashes or economic recessions do not occur overnight. There is always a long build-up of sequential events. We may not notice them or even if we notice, we tend to overlook them as insignificant. When things reach to the extreme level, some such seemingly insignificant event works as a trigger for the catastrophe. After a long spell of booming stock/debt markets, geo-political tensions, non-stopping exploitation of natural resources and high levels of environmental contamination, the trigger for worldwide recession has come this time in the form of deadly infectious virus named COVID-19, which is the abbreviated form of Corona Virus Disease of the year 2019. It originated in December 2019 in Wuhan city of China and then spread to other countries and by March 2020, the pandemic COVID-19 firmly gripped the whole world in its clutches. Most of the countries declared emergency lockdowns to control the infection. 

Specifically talking in the context of India, life came to a halt since declaration of “Janata Curfew” on 22 03 2020 and official Lockdown1 of three weeks from 25 03 2020 followed by Lockdown2 (up to 14 04 2020) and Lockdown3 (up to 17 05 2020). "Social Distancing" and "Stay Home, Stay Safe" have become the new watchwords. We were all unprepared for such a rude shock of strict Lockdown. The Government’s order froze all the socio-economic activities in a single stroke at the midnight of 24 March 2020.  The only aberration amidst the COVID-19 curfew is the Share Market, which after some initial knee-jerk reaction and sharp price fall in March 2020, resumed its trading vibrancy and excitement. Its vibrancy is all the more conspicuous when almost all other economic activities right from factories/businesses/offices to restaurants are shut down; no buses, no trains, no flights, no autos, no cabs and even no private cars and 2-wheelers are seen on the deserted roads and streets. Nevertheless, the Share Market punters, sitting smugly in their chairs with computer screens in their front, are busy swinging as usual with the market fluctuations.  Of course, initially there were demands from some quarters for closing the Share Markets also. But strangely enough, Share Markets all over the world continued their business unabated. I have no grudges whatsoever about the Share Market being open even when every other market is closed. At least, it has kept people occupied with their daily dose of share sale-purchase pursuits.

What is puzzling most in the whole process is the fact that despite clear signs of imminent economic slow-down, share indices shot up by 2-3 per cent in a row. Amid the countrywide Lock Down in India, the benchmark index NIFTY rose in 10 sessions out of 18 trading sessions in the month of April 2020. It registered a net increase of 14.68 per cent from 8597.75 on 31 March 2020 to 9859.90 on 30 April 2020. Thus, April 2020 emerged as the best month for highest increase in the NIFTY share prices after May 2009. Furthermore, share prices continue to rise in the current month of May 2020 as well.

When the news of Corona eruption gripped India in March 2020, share prices dropped by 23 per cent. Thereafter, the economic situation further worsened in India as well as the world. But April onwards share prices rose even though global economic slowdown is amply reflected in the major key indicators as under:

·        According to a March 2020 report titled “The COVID-19 Shock to the Developing Countries” by The United Nations Conference on Trade & Development (UNCTAD), “Even so, the world economy will go into recession this year with a predicted loss of global income in trillions of dollars.”

·        According to the IMF outlook report (April 2020), the economic growth rate in Asia is expected to be zero and the global GDP may decline by 3% with per capita income falling in 170 countries of the world in the wake of COVID-19.

·        The Economist (02 05 2020) reported that lockdown in all the major countries will adversely affect the productivity and return to normalcy will be a slow journey as the Consumer spending is down by 40 – 80 per cent.

·        Goldman Sachs survey (April 2020) revealed that two–third of small businesses in the U.S.A. will be out of cash in the coming three months. As many as 30 per cent business firms in Britain have not paid rentals.

·        It is not certain how long the governments of the U.S.A. and European countries will continue to fund unemployment allowances and other popular social security benefits.

·        The IHS Markit India Manufacturing Purchasing Managers’ Index (PMI) hit record low of 27.5 in April 2020 from 51.8 in March 2020. This is the sharpest fall since the PMI was started in India 15 years ago.

·         Auto Sector in India recorded zero sales of vehicles in the month of April 2020 and the early recovery prospects are bleak. More or less similar are the performance reports of other sectors.

In the backdrop of such a grim economic scenario world over, steep rise in share prices during April 2020 is somewhat bizarre and may become a cause of serious concern in the coming months. Market experts have cited the following reasons for such a high optimism in the equity markets:

·         Hopes of relaxations in the lockdown

·         Hopes of early availability of Corona vaccine

·    Better than expected financial results by the tech giants like Face Book,  Microsoft etc.

·         Zero/very low interest rates

·         Low crude prices

·         Relief packages/bailout for industries/businesses by the governments

·         Loan moratoriums etc.

On delving deeper, the above assumptions sound like hoping against hope. Such assumptions may be valid in normal times but not in the present grave pandemic lockdown situation. Reports are not encouraging from the countries where lockdown is relaxed. Though medical scientists are working hard for developing an effective vaccine, it is a well-established fact that any new medicine/vaccine requires a minimum period of 12-18 months for trials before its final approval. Optimism arising out of recent good financial results by tech giants is hollow because these results are for the past period. As regards hopes of State assistance, the governments cannot continue for long to fund the ever-increasing expenses with their limited resources and revenues shrinking due to continuous lockdown. Before the onset of COVID-19, budget forecasters had projected the USA Government budget deficit around $1.00 trillion. To fight the onslaught of COVID-19, budget forecasters are now projecting that the government budget deficit will run over $3.5 trillion because of huge jump in Govt. spending coupled with steep decline in the revenues. The brutal demon COVID-19 has already badly bruised the global economy with no immediate relief in sight and the recovery is going to be very slow and painful.

In such a grim economic scenario, current frenzy of the Equity markets may turn out to be a highly speculative misadventure because there is an underlying correlation between a market crash and economic recession. Taking a cue from the world history of pandemics and economic recessions, it will not be out of place to draw a parallel with the Great Economic Depression of 1930. Going by historical trends, world has experienced periodical business slowdowns of different time spans. We are now at the onset of a centennial recessionary business cycle like that of 1930. Similarities in market configurations of 1920 and 2020 are so striking that we cannot afford to ignore them. Let us understand the making of world’s greatest and longest Economic Depression of 1930s. During the decade prior to 1930, there was speculative build up of positions by investors/market players in real estate markets and the New York Stock Exchange (NYSE). Unregulated liquidity fuelled by margin trading led to highly inflated asset prices. Equity prices rose to all time high multiples of more than 30-times earnings (P/E Ratio). The benchmark Dow Jones Industrial Average (DJIA) Index was up by 500 per cent in a matter of just 5 years. It was a Black Thursday on 24 October 1929 when the NYSE crashed. There was a brief rally on Friday, 25 October and during a half-session on Saturday, 26 October 1929. But after the weekend, there was horrible bloodbath in the Equity markets on Black Monday (28 10 1929) and Black Tuesday (29 10 1929). Dow Jones fell by 20 per cent in those two days followed with eventual blow-by-blow 90 per cent fall of stock markets. The shock waves reached to Europe also, triggering other financial crises such as the collapse of Austria’s bank Boden-Kredit Anstalt. Subsequently, many bank runs/failures occurred in Europe and the U.S.A. causing loss of public confidence in financial institutions.  In 1931, the economic contagion hit the U.S.A., Europe and other major economies of the world with full force. By 1933, unemployment was at its peak, majority of the population was poverty-stricken, a large number of industries/businesses had to down their shutters, and essential goods were in short supply.

Though the stock market crash of October 1929 was the immediate trigger for the onset of 1930’s Great Economic Depression, the definitive build-up to it started with the ravages caused by the World War I (WWI) and the Spanish Flu (1918-20):

• World War I (1914-18): Although there is no consensus about the root cause of the Great Depression, a look at the post-WWI sequence of events, gives a fair idea of the socio-economic damage caused by the WWI (1914-18) and Spanish Flu (1918-20). Initially, America was not directly involved in the WWI, but it financially supported the Allied nations of Europe. After the war, America wanted Allies to repay the money lent by it to them for funding the war. The Allies took the stand if they have to repay to the U.S.A., they would have to recover reparations from Germany who initiated the war and was defeated. Accordingly, Germany and the Allied Nations (Britain, France, Italy and Russia) signed the Treaty of Versailles on 28 June 1919. In terms of this Treaty, war hostilities ended and it required Germany to pay billions of dollars to the Allied Nations in reparations for war damages. Heavy reparations further impoverished Germany and led to irreparable damage to the European economy as a whole.  In a vicious circle of payments, Germany borrowed money from America to pay reparations to the Allied Nations, who in turn repaid to America. Soon a stage came when Germany was no more in a position to honour its commitments and the Allied Nations did not agree to relax the terms of reparations. As a result, Germany defaulted on its payments in 1923, its economy almost came to a halt as France and Belgium occupied industrial Ruhr region to force German repayments. Left with no other alternative, Germany increased currency printing to meet repayment obligations. It caused a hyperinflation and Mark, the German currency, became worthless in value. It had a crippling effect on the European economy, which in subsequent years adversely affected the American and the world economy as a whole.

Herbert Hoover, who was the U.S. President during the Great Depression, wrote in his Memoirs (1952), “The primary cause of the Great Depression was the war of 1914-18. Without the war, there would have been no depression of such dimensions.”   
     

• Spanish Flu (1918-20): In a way, it was the after-effect of WWI as thousands of corpses rotted in the remote battlefields all over the Europe and H1N1 virus caused a new strain of influenza. It was detected in the U.S. military personnel in 1918 spring. Interestingly, it was named as Spanish Flu because Spain was neutral in the WW1. While the other warring nations did not report the actual number of infected persons, neutral Spain could report the factual severity of the pandemic. Though different figures of the total infected persons and deaths are quoted, the estimated number of infected persons at its worst was 500 million, which was about one-third of the world’s population at that time. Deaths from Spanish Flu are estimated from 50 million to 100 million across the globe. This pandemic further damaged the world economy because of lockdowns.       
• Forgotten Depression: The adverse economic effects of the Spanish Flu triggered the recession in 1920-21 when the U.S. Stock markets slumped by 50 per cent and corporate profits shrunk by 90 per cent. Market crash of 1920-21 is also called as the Forgotten Depression because soon after it the U.S. economy registered robust growth till 1929 and the Americans enjoyed the gains of Stock Market as if there was no tomorrow. The frenzy of Roaring Twenties tempted the public to put their hard-earned savings in the Stock Markets where prices were at their peak.

Similar to the background of Great Depression in 1930, discords and clashes among nations have become order of the day under the current geo-political situation in many parts of the world. On the economic front, sectors like automobiles, real estate etc. are already under severe pressure while the stock market valuations are high. According to some market experts, COVID-19 may prove to be a trigger for the onset of 21st century’s Great Depression. It is difficult to predict exactly the gestation period of recessions, because their actual occurrence depends upon a number of variable factors. Looking to the inherently uncertain nature of economic outcomes there may be time lags, but we cannot rule out the threat of impending economic recession. All said and done, we cannot ignore the unsettling effect of pandemic like COVID-19 or geo-political tensions on stock markets and economy. In an interview to the CNBC at the World Econoic Forum on 23 01 2020, Antonio Guterres, UNO Secretary General said in no uncertain terms that the state of global geopolitical tensions is high, and this is having an impact on the global economy.

It is said that uncertain times breed high volatility in the markets. Market volatility on the one hand offers opportunities for high gains. On the other hand, it also lays traps for investors. Retail investors are most vulnerable to lose money in volatile markets because interplay of Greed and Fear confuses the retail investors’ minds. While there is a temptation to buy stocks at all-time-low prices, the fear of losing the money is also equally strong. That is why “caution” is the watchword for retail investors and they should adopt the following time-tested precautionary, conservative approach in the volatile and recessionary periods:

• We should be active in the market but our focus should be on the “sell side” for booking profits.
•  Keep 35 per cent of investible funds in cash or cash equivalents.
•  Strictly observe pre-defined Stop Loss Limits and Profit Booking Limits in the portfolio.
•  If we come across any excellent buying opportunities, our preference should be        

1.    consistently profitable, dividend paying companies with Zero/low debt;

2.    well-established large cap companies from "A" Group who are market leaders with good track record in their respective fields;

3.    stocks of above category of companies particularly from the defensive sectors like Pharmaceuticals, Utilities and FMCGs;

•         Invest own funds and not borrowed funds.
•         Do not indulge in speculative Intraday Trading.
•         Midcaps, Small caps, banking and finance stocks are generally the            worst hit in recessionary periods. 
•         Accumulate slowly and gradually because markets tend to make new        bottoms with deteriorating economic conditions during the recessionary      periods.
•         Say a firm and bold “No” to impulsive buying sprees.  
•         Buying decisions should be based on fundamentals and not on the            so-called “hot tips”.

The above is only an indicative and not an exhaustive list of precautions. In fact, these are the common precautions known to everyone with some experience of stock markets. Nevertheless, these time-tested Golden Rules need to be hammered deep down in our consciousness because Behavioural Finance studies show that investors as human beings are not always rational, they have a limit to their self-discipline and their decisions are influenced by their own biases. It is all the more so in the case of retail investors who are highly vulnerable in times of market turbulence and volatility.

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