The Shape of Recovery: Will Animal Spirits Reawaken?

05.06.2020 - Viraj B. Patel, CFA, FRM, CAIA

Key Takeaways
  • The unprecedented nature of COVID-19 required an equally unprecedented policy response—making a variety of recovery paths possible.
  • Our team thinks the shape of recovery depends on five themes:
    • Reopening the economy
    • The possibility of a second wave of contagion
    • Changes in business and consumer behavior
    • Clarity on how policy will be transmitted into the real economy
    • Insight into corporate fundamentals
  • Uncovering the effects of government stimulus and whether these efforts can reenergize the “animal spirits” within the global economy will be critical.
  • We remain cautious and have reduced exposure to international large-cap stocks.

With COVID-19 leading to a global lockdown and a sudden stop in world economic activity, global policymakers provided a swift and dramatic response to the unprecedented crisis, leading to a variety of potential recovery paths that may vary by sector, industry and even individual companies.  A very high degree of uncertainty still surrounds both the depth and magnitude of the impending recession and the eventual shape of the recovery, especially with the huge scope and size of the support packages supplied by monetary and fiscal authorities. Gaining a clearer picture of the economic landscape is crucial in determining who will win and who will lose as we emerge from this downturn. 

Five Themes We Are Watching

Our asset allocation approach seeks to uncover the effects of the ongoing government stimulus and whether these efforts will be able to reenergize the so-called “animal spirits” within the global economy.  Helping form our overall assessment will be gauging the speed and precautions that policymakers use while reopening their economies, the likelihood of a second wave of contagion causing a new round of shutdowns later this year and whether the behavior of businesses and consumers will change as economies reopen. Also, visibility into macroeconomic (national) and microeconomic (company) data will be critical in determining which regions/countries and asset classes to favor and which to avoid.

To gain more insight into the recovery process, we are monitoring five themes across global markets.

  • Reopening the economy

The longer the economy remains closed, the larger the number of businesses that will likely go bankrupt, and the more workers will end up unemployed on a non-temporary basis. The possible erosion of both human and physical capital that might follow on the heels of this trend could undermine the recovery. For this reason, restarting economic activity seems to be increasingly viewed as a policy priority globally. For example, in Europe, a number of countries have moved in this direction already and have allowed some manufacturing and construction activity to come back online. In the US, the Trump administration has issued guidelines to help states chart their individual paths.

  • Risk of a second wave

While many experts expect that coronavirus will return in the fall, the question is with what intensity. Policymakers appear to be well aware that if contagion flares up again and forces a renewed shutdown, the economic and health consequences will be catastrophic. Therefore, our assumption is that while reopening the economy officials will adopt the necessary precautions to prevent such an outbreak. This will probably encompass efforts on several fronts including antibody testing, therapies and vaccines. We consider a scenario in which a second wave with an intense contagion effect occurs to be a high-impact but low-probability event.  

  • Changes in business and consumer behavior

Will people be more reluctant to travel by plane, go to bars and restaurants, take public transport or live in big cities? We believe to some extent the answer is yes, at least in the first few months after the economy reopens. But the intensity and duration of behavioral changes will likely vary across age brackets, reflecting different risk factors, and across countries, revealing different cultural specificities. Potential shifts in consumer behavior are some of the factors that we consider in determining the different outcomes of recoveries within various sectors of the economy. A real risk to a consumption-driven economy would be if a broad swath of households decided that a rational response to the crisis is a higher level of household savings.

  • Policy impact on the real economy

Not only was the proverbial “kitchen sink” thrown at the real economy, the speed at which monetary and fiscal measures were implemented was unexpected and welcomed by many market participants.  We think these measures supported the move off of the March 23 low point for equities as it established a floor for sentiment and helped reduce the possibility of a worst-case scenario for financial markets.  For a sustained move higher in equities, we believe a catalyst such as a fundamental improvement in economic data would be seen positively. While policymaker’s open-ended responses may have been enough to provide a market bottom, we seek further evidence that these policies are effectively shifting consumer sentiment in supporting economic activity.

  • Insight into corporate fundamentals

With the lockdown efforts causing a sudden stop in economic activity, the depth of the contraction is still difficult to gauge.  While we know economic activity will be disappointing, we have been operating in a “black box” from a macro perspective.  This has forced investors to turn to companies to gain any insight into the damage caused by COVID-19.  Although we are moving through the earnings season, many firms have already withdrawn their earning guidance for the year. [1]   For investors, such a void creates heightened uncertainty and limited visibility over the near term.  However, based on recent market performance, many participants appear to be looking past these unknowns. For now, without any additional clarity, we believe that the current disconnect between equity prices and corporate fundamentals skews potential risks to the downside.

Asset Allocation: Underweight International Large-Cap

In the absence of a clearer economic picture, we felt it prudent to maintain an underweight recommendation to equities. Though a timeline has been proposed by a few countries to reopen their economies, these measures appear to be slow and calculated, and will likely continue to weigh on economic activity. Such challenges resulting from the halt in global economic activity could have a knock-on effect in overseas markets, particularly on international large-cap equities, which already faced structural headwinds moving into the crisis. 

Our cautious view has led us to lower our exposure to international large-cap stocks which we think is supported by several additional factors:

  • European policy responses may have limited impact on the regional economy due to the apparent lack of coordination among member countries
  • Foreign central banks have tended to be more constrained than the Federal Reserve
  • Based on their greater exposure to manufacturing, international markets appear to be more impacted by the supply and demand shock
  • Overseas markets seem to have fewer secular growers, i.e., companies whose growth remains consistent regardless of the economy than the US.

Peter Repetto, Asset Allocation Associate, contributed to this article which also leverages content previously published by our colleagues, Sonal Desai, Ph.D., Chief Investment Officer, Franklin Templeton, Fixed Income and Nikhil Mohan, MSc Economist, Research Analyst, in “US Macro Outlook: Let's Bend the Economic Growth Curve” (April 22, 2020).


The information provided is intended solely to provide general information. The information and opinions stated may change without notice. The information and opinions do not represent a complete analysis of every material fact regarding any market, industry, sector or security. Statements of fact have been obtained from sources deemed reliable, but no representation is made as to their completeness or accuracy. The opinions expressed are not intended as individual investment, tax or estate planning advice or as a recommendation of any particular security, strategy, or investment product. Please consult your personal advisor to determine whether this information may be appropriate for you. This information is provided solely for insight into our general management philosophy and process. Historical performance does not guarantee future results and results may differ over future time periods.


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