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Economics | March 30, 2020

COVID-19: Making sense of the economic impact Economic and financial issues � COVID-19 economic and financial impact: Will the economy go into recession? When will the sharemarket

volatility stop? What will happen to property prices?

Analysis of past economic cycles can provide guidance for consumers and investors.

Will the economy experience a recession? • Economists just love to forecast. And forecast often. Indeed they can’t

help themselves – even when there is a paucity of past experiences to provide guidance, economists are out there forecasting.

• At this stage, clearly it is near impossible to make accurate predictions. Much depends on how quickly the number of COVID-19 cases can be controlled. Also much depends on how quickly treatments and a vaccine can be found for the virus.

• These are extraordinary times with no exact precedent.

• The best approach to forecasting is shown by the International Monetary Fund, expressing in general terms the likelihood of a global recession in 2020 but not speculating on the size of the fall.

• Australia is also at risk of recession. But it is important to note that the Reserve Bank and Federal, State and Territory governments are providing massive support for the economy and financial markets. The economic impact of COVID-19 is also quite variable across businesses and sectors. Travel, recreation and hospitality businesses have been most affected. But supermarkets, electrical goods stores, some transport businesses and sporting goods retailers have noted firmer demand. And infrastructure construction has been little affected.

• Notably, in past recessions caused by an external shock (such as 1975 due to the oil price shock), the Australian economy has bounced back quickly. But again, much depends on how quickly the virus can be contained.

The Global Financial Crisis (GFC)

• The keenness for economic forecasting was certainly a feature of the Global Financial Crisis (GFC) – an economic event with few parallels. Economists were certain that Australia would follow the world into recession. But recession was avoided. (A recession is typically defined as two consecutive quarters where economic activity (gross domestic product or GDP) declines.)

Recessions in Australia1959-2019

fall, pct pointsperiod, quarters

1.8Jun 61 - Sep 611.5Dec 71 - Mar 722.6Sep 75 - Dec 750.7Sep 77 - Dec 771.2Dec 81 - Mar 823.4Sep 82 - Jun 831.4Mar 91 - Jun 91

Source: ABS, CommSec

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Economic Insights. COVID-19: Making sense of the economic impact

• In October 2008 and February 2009, massive stimulus was provided by the Government and central bank, and it worked to stabilise the economy. In fact when we look back at the GFC many actually believe that the economic support measures were too generous. The economy contracted 0.5 per cent in December quarter and GDP bounced back by 1.0 per cent in the March quarter. The economy didn’t experience another quarterly contraction in output until March 2011 (Cyclone Yasi) even including the period of the 2009 swine flu.

Past recessions

• But this period is different. It has been caused by an external shock – and indeed a medical, not financial shock. Most downturns or recessions – both here and abroad – have occurred through financial means, basically policy mistakes. That is, central banks have responded to periods of “irrational exuberance” by lifting rates too far, causing people to cut spending, and causing businesses to trim spending, hiring of staff and investment.

• So when have recessions occurred in Australia? There have been seven periods of recession since quarterly records were first maintained in 1959: 1961, 1971/72, 1975, 1977, 1981/82, 1982/83 and 1991 (many observers view the period from 1981-1983 as one event). Clearly there were also economic downturns before 1959 such as the Great Depression.

• The common finding is that most of these periods of recession also occurred in advanced nations, notably the US. Most recessions occurred after a period of tighter financial conditions.

• One downturn of note was 1975. And the US and other advanced economies also experienced recessions at that time. The US was in recession from November 1973 to March 1975. And a key cause was an external “shock” – a financial rather than medical event – the first oil shock in 1973 when oil prices soared by 400 per cent in response to an oil embargo. Central banks responded to soaring inflation by lifting interest rates.

• In January 1973 the 90 day bank bill rate was 4.70 per cent. Rates steadily increased over 1973 and 1974, peaking at 21.75 per cent in May 1974. Ahead of the 1975 recession, 90 day bills still stood at 9.8 per cent.

• Interestingly the Australian economy contracted by 2.6 percentage points over the September and December quarters of 1975 and then rebounded 4.4 per cent in March quarter 1976, expanding over the next year.

Medical emergencies

• Three medical emergencies that are most cited are SARS (Severe Acute Respiratory Syndrome) in 2003, swine flu in 2009 and the 1919 Spanish influenza. The SARS epidemic first appeared in late 2002 in Guangdong, China and ended in July 2003. Swine flu appeared in April 2009, extending to August 2010.

• The main impact SARS had on the Australian economy was on the travel sector. Australian GDP was weak in 2003, rising just 0.4 per cent in the first half before rebounding 3.4 per cent over the second half of the year.

• Assessing the impact of the 1919 Spanish flu is complicated by the end of World War 1. It has been estimated that real aggregate gross domestic product declined by 9.5 percent between 1914 and 1920. The loss of 60,000 service people in the war depressed economic activity, and extended through the early 1920s.

Unemployment

• In past economic downturns, unemployment has understandably lifted. But, as stressed, no two periods are the same. While Australia didn’t experience a recession in the GFC, the unemployment rate did lift in the slower economy – lifting from 4 per cent to 5.9 per cent in the space of 11 months.

• In the recessions of 1990-1991 and 1981-83, unemployment rose from 5-6 per cent to 10-11 per cent in around a two-year period.

• In the current period, the jobless rate stands at a near 8-year low of 5.1 per cent. As the downturn has been caused by an external ‘shock’ the jobless rate will likely rise more quickly. A raft of retail, hospitality, arts and recreation staff have been stood down. However, job creation is occurring in supermarkets, grocery stores, some health businesses and delivery/courier businesses.

• While unemployment will likely lift quickly to record levels, the government has lifted cash payments to prevent

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Economic Insights. COVID-19: Making sense of the economic impact

broader job losses. It is anticipated that jobless rates will fall quickly when the virus is contained and businesses are allowed to re-open.

Sharemarket impact • It may sound like a broken record but these are extraordinary

times with no exact precedent. The volatility has been breath-taking as has the speed of sharemarket falls from highs.

• After hitting record highs on February 20, the All Ordinaries index entered a ‘bear market’ 12 days later, down 21.3 per cent from highs. A bear market is generally defined as a fall of more than 20 per cent from highs.

• The US Dow Jones index took 18 days to fall by more than 20 per cent from the February 12 record high.

• The key issue for investors has been the difficulty in valuing companies in response to a largely unique external shock.

• Past sharemarket downturns have been induced by economic or financial factors.

• The speed of the current sharemarket contraction has similarities to the October 1987 sharemarket crash. On both occasions, sharemarkets were perceived to have become expensive, raising the prospect of corrections or a period of market consolidation to restore value for investors.

• Interestingly, in the current period, sharemarkets initially were supported despite news of COVID-19. The initial perception was that the virus would be confined to China and the economic impact would be limited to ‘supply chains’ across the globe.

• In 2007, it took 84 days for the All Ordinaries index to fall more than 20 per cent from the highs. In 1987, the sharemarket hit highs on September 21. It took 20 days for the All Ords to fall 10.9 per cent off its highs, before the massive 25 per cent fall on October 20.

• Compared with 2020, again there was nowhere near the speed of falls in sharemarket declines over periods such as 1970-74, 1981-82, or 1990/91 when there were times of economic downturn.

Looking back even further

• Data on the Australian sharemarket goes back to 1875 although the first sharemarket was formed in Melbourne in 1861. There have been numerous events and shocks over time to affect the sharemarket including wars, commodity price shocks (oil, wool), financial crises and the technology crash.

• But in terms of the severity of the downturn and volatility of the sharemarket, the COVID-19 virus crisis has few parallels. It is good to know that there is such a rich history of data to research. The important point is that each experience is different, especially in times of recovery from lows. But experience shows that it can take time for the sharemarket to regain highs. While no two periods are exactly the same, the sharpness of the current decline in share prices may lead to a quicker recovery process.

• In relatively recent times, in 1960, it took 42 days for the sharemarket to fall 20 per cent from the September 16

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Economic Insights. COVID-19: Making sense of the economic impact

high. It actually took 717 days for the sharemarket to regain its 1960 highs.

• In the Great Depression, it took 6½ years for the Australian sharemarket to regain the February 1929 high. And it took more than 6 years for the September 1875 high to be exceeded.

• Still, in weak economic times and affected by the Spanish flu, the sharemarket actually rose 19 per cent over 1919 and 1920.

Residential property prices

• In Australia, consistent data on home prices goes back to 1980. It is also important to note that there can be marked differences in property cycles. For instance in the current environment, Perth and Darwin are at different points in the cycle from, say, Hobart or Canberra.

• In the 1982 recession, house prices peaked in April 1982 and fell 6.4 per cent over the next year. It took 21 months to regain its previous highs.

• In the 1990/91 recession there was no appreciable downturn in house prices.

• In the 2007/08 GFC, house prices peaked in February 2008 and then fell 8.5 per cent over the next 11 months. It took 21 months for house prices to regain previous highs.

• In the current period, house prices fell 9.3 per cent in the 21 months from October 2017. In the recovery since August 2019, house prices have lifted 7.8 per cent.

What are the implications for investors?

• These are extraordinary times. Australia and the globe are experiencing a shock like no other. But it is important to note – unlike periods such as the Great Depression – governments and central banks are ‘doing all that it takes’ to support businesses, workers and the more vulnerable members of society.

• Labs are working on vaccines and treatments such as those for malaria and tuberculosis are showing promise in killing the virus.

• Economies were in good shape ahead of the crisis, in fact it was hard to find better economic ‘fundamentals’ in Australia.

• While it will be hard to avoid recession in Australia, it is not impossible. Sharemarkets will settle when virus cases peak (the curve flattens). And while unemployment will likely lift to historic highs, people will quickly return to work when businesses are allowed to re-open.

Craig James, Chief Economist, CommSec Twitter: @CommSec

March 30, 2020 5

Economic Insights. COVID-19: Making sense of the economic impact

Date Event & Impact on US Dow Jones & Australian ASX 200 Daily %

Feb-28 Chinese purchasing manager indexes hit record lows Dow -1.4%

ASX -3.3%

Mar-02 Hopes for fiscal/monetary stimulus from G7 nations Dow +5.1%

ASX -0.8%

Mar-03 US Federal Reserve cuts rates 50bp to 1.00-1.25% Dow -2.9%

Reserve Bank cuts cash rate 25bp to 0.50% ASX +0.7%

Mar-04 Victories in 'Super Tuesday' primaries by moderate Democrat Joe Biden Dow +4.5%

provides relief for investors ASX -1.7%

Mar-05 Swift spread of COVID-19 through the US Dow -3.6%

ASX +1.1%

Mar-06 Oil prices slump 10% as OPEC+ fai ls to cut output Dow -1.0%

ASX -2.8%

Mar-09 Oil falls another 25% on fear of a Russia-Saudi Arabia oil price war Dow-7.8%

S&P 500 index fell by 7%, triggering the level 1 circuit breaker ASX -7.3%

Mar-10 Investors await US White House response to COVID-19 Dow +4.9%

Oil rebounds by 10.4% ASX +3.1%

Mar-11 World Health Organisation declares COVID-19 a global pandemic. Dow Dow -5.9%

enters bear market. Bank of England cuts rates 50bp to 0.25% ASX -3.6%

Mar-12 US President restricts air travel with Europe. Disappointment at the Dow -10%

absence of US stimulus plan. First Australian stimulus package ASX -7.4%

Mar-13 US declares national emergency resulting in US$50 bil l ion of Dow +9.4%

federal aid being advanced ASX +4.4%

Mar-16 RBNZ and US Federal Reserve both cut policy rates to 0.25%. Dow -12.9%

US S&P 500 index fel l by 8%, triggering the level 1 circuit breaker ASX -9.7%

Mar-17 US White House works on stimulus plan estimated at US$1 tri l lion Dow +5.2%

US Federal Reserve buys debt directly from companies ASX +5.8%

Mar-18 New York Fed makes $1 tri ll ion a day available for repo operations Dow -6.3%

Investors await US White House response to COVID-19 ASX -6.4%

Mar-19 Bank of England cuts rates to 0.1%. US opens swap lines. European Central Dow +1.0%

Bank buys $820bn in debt. RBA stimulus package, cash rate cut to 0.25% ASX -3.4%

Mar-20 New York & California issue "stay at home" orders Dow -4.6%

Nymex oil falls 10.7% ASX +0.7%

Mar-23 2nd fiscal stimulus package in Australia (Mar 22). US Federal Reserve places Dow -3.0%

no l imit on purchases of Treasury and agency mortgage-backed securities ASX -5.6%

Mar-24 US Congress moves closer to agreeing an economic relief package. Dow Dow +11.4%

Jones posts biggest daily percentage gain since 1933. ASX +4.2%

Mar-25 US Congress close to a vote on a US$2 tri l l ion economic relief package Dow +2.4%

But US stocks lose ground into the close on 'snags' in the package progress. ASX +5.5%

Mar-26 US Senate approves relief package, awaits House of Representatives vote Dow +6.4%

European Central Bank will not cap bond purchases to any one country ASX +2.3%

US unemployment claims soar to record 3.28 mil lion

Mar-27 US President approves a US$2.2 tri l lion relief package Dow -4.1%

US Dow Jones rises 12.8% over the week, the best gain since 1938 ASX -5.3%

Mar-30

Mar-31

Source: CommSec