A short note on possible economic and financial fallout of the pandemic
The path of the stock market will depend on
Short-run: Fiscal and monetary stimulus packages. How committed governments and international institutions are to stand behind domestic economy and financial system.
Short-run: Number of cases/recoveries and deaths.
Long-run: build-up of herd immunity, development of vaccine.
Long-run: ability of governments to sustain stimulus beyond several months.
At the moment both short-run factors are pointing at positive direction. All governments seem to stand behind the economy. By far the largest stimulus package. Many support packages address needs of the day labourers and affected industries, provide business loans and government guarantees to support the liquidity.
From health perspective numbers look promising too. Quarantine measures seem to be working as the numbers in Italy, Spain and many hard-hit countries start declining (with the exception of US and UK, which is normal since virus peaked late in these countries).
Combination of massive stimulus and flattening of the curve and plans to restart the economy (Demark, Norway, even Italy are opening up non-essential businesses and schools) result in optimistic outlook which explains recovery despite dire economic forecasts by IMF and the rest.
From here on 4 scenarios are possible (with the probabilities I assign to them):
Best case scenario: V-shape recovery (1%)
Economies in Europe, America and elsewhere open up
Herd immunity is built quickly
Stimulus helps to save businesses and the poor
Consumer and business confidence comes back quickly
After a sharp downturn in Q2, economy recovers by Q4
Buy now if you believe in this scenario.
Great scenario: U-shape recovery (49%)
Economies open up gradually.
No second wave of the virus owing to continuous social distancing measures and herd immunity.
Certain industries grow quick (perhaps restaurants, cafes, barbers) but growth in other industries is sluggish (airlines, entertainment).
Overall, a U-shape recovery over a year or so.
Buy now if you believe in this scenario.
Really bad scenario: L-shape (40%)
The virus hits with the second wave and forces closures of businesses in advanced economies.
Further, virus spreads larger geographical areas killing and infecting more and more people than the first wave.
Perhaps if it does, then it will happen sometime around May-June, since many countries are already planning for easing quarantine measures.
If this happens perhaps second wave of shock and sell-off will push markets deeper, with L-shape performance from this period onwards.
Cash is the king
Greater Depression scenario: I-shape (10%)
Prof. Nouriel Roubini coins this I-shape case as a Greater Depression
Cases rise as a result of the second wave
Stimulus packages run out of steam
Ongoing combination of demand shock and supply shock due to quarantine measures, monetarization of stimulus packages by printing money results in stagflations- a combination of high inflation (in some countries perhaps hyperinflation) and high unemployment and severe output contraction.
Old but GOLD!
We will most likely see important changes over the long run (next 2-5 years)- here I am with Ray Dalio and other economists who have said that fundamentals and markets have decoupled over recent decade. Too much capital flow to share markets, record level of household and public debt, purely growth driven economy with no regards to sustainability, massive and growing inequalities everywhere in the world- all these cannot be sustainable as many note.
In most dramatic case, there will be some sort of new economic model (maybe over longer period of time). At minimum though we will some changes in our existing economic model with a combination of some elements from below (I would call this new socio-capitalism):
Social and economic restructuring, including debt forgiveness and restructuring (both household and public debt). IMF and WB are already calling for debt forgiveness for poor countries. Argentina is considering default (yet again!).
Rise of sovereigns: stronger governments with more control over people
More isolated governments
Relocation of supply chains
Nationalization of big companies (perhaps airlines are already there)
Move towards trade restrictions and more self-sufficiency