Economist interview: recession, stocks and recovery

[00:00:00] Speaker 1: With me today I have Fernando Fernandes, former senior economist at the International Monetary Fund, ex-chief economist and head of research at Banco Santander, and currently economics professor at IE Business School. And we're going to talk about the possible corporate and economic repercussions of the coronavirus epidemic. First of all, the coronavirus pandemic and subsequent lockdown have made a global recession almost inevitable. I mean, how bad do you think [00:00:34] Fernando Fernandes: it will be? Well, it's clear by now that it's going to be very bad. It's probably going to be the biggest recession that we have seen since probably the Great Depression, or at least compared to World War II. Because it's important to understand that this is the only time that I can think of that the actual economy has been closed down for two months. And that's what happened in many parts of the world, in many countries. So we now have the, for instance, the estimates coming from the IMF spring meetings, where they're looking at an unprecedented falling world GDP of 3%, with a drop in Europe of 7.5%, in the US of 6%. So we're seeing really a huge global recession. Now, of course, the big question here is how long will this last? How temporary the recession is? And that's probably more important than today to discuss the length of the recession. [00:01:25] Speaker 1: There are lots of comparisons made with the 2008-2009 Great Financial Crisis, which is driven by the banks. So how different do you think this downturn might be? [00:01:36] Fernando Fernandes: We, economists and analysts tend to compare crisis because, you know, we basically do compare analysis. But I think we all have now come to the conclusion that this crisis is very different. It has nothing to do for all these reasons. First of all, it's not a crisis that is the byproduct of problems in the financial markets or banks. Banks are, if anything, today more solvent, significantly more liquid, and certainly more careful in their lending than they were in the financial crisis. So this is not a crisis that comes from problems in the financial crisis. This is actually not a crisis that comes from companies being over-leveraged or over-indebted. We are not seeing a crisis in which credit-worthy companies have disappeared, or the assessment of the credit worthiness has changed because of internal problems of the companies. So this is not a crisis that comes from the financial sector. It's not a crisis that comes from the economy in itself. This is a crisis that comes from a pandemic. So this is a health emergency that has resulted first in part of the global factory. The world factory stopped for a time. This is the initial part of the crisis when China stopped producing and manufacturing goods. Then it became a crisis where people could not go to work, but this is a crisis then that is born and will be solved outside economy. The only thing in the economy, both economic, financial and monetary policies and fiscal policies, the only thing they can do is, and it's very important, two things. One, make sure that the crisis, the health crisis does not reflect more than necessary in a huge economic recession, and therefore they need to provide liquidity to make sure that the money money goes on. And second, try to create a social safety net to make sure that the economy, the people can live and the economy can work temporarily while we come and find a health remedy to this health crisis. [00:03:40] Speaker 1: And how could that be reflected in global financial markets? Stocks remain sharply lower in 2020, but a significantly higher than their worst levels. I mean, do you think they correctly price in a severe recession? [00:03:54] Fernando Fernandes: Well, I think stock prices are reflecting a very sharp recession. You know, we don't typically see a 20-30% drop in stock prices. So it is a huge recession. But I think they're also forecasting a short recession. They're expecting the economy to be able to function basically normal again sometime around the end of the year. If that is the case, if that is the case, I think stock prices probably may have even overshoot at some point. I mean, we will see some industries behaving much better than we're anticipating today, if again, there's a scenario that things go back to normal towards the last quarter of the year is right. So what we will see probably is a lot of volatility in stock markets. Why? First, because, as I said, the length of the recession will be subject to a lot of news coming from outside the economy, coming from the medical and the health sector and discussion about developments of a new vaccine, etc. This will affect the probability of the economy to go back to normal and therefore the stock prices in the sense that they discount future sales to make it sort of very, very, very simple. So we will see a lot of volatility. That's what worries me. We will not see, as we saw in previous crisis, lack of liquidity in the sector because we know now for sure that the monetary authorities will do whatever it takes and literally whatever it takes to make sure the liquidity is in the market. So they will not be necessarily points of huge stress in any financial market. And that's good. And we will see, as we go along the crisis, a reappraisal of investors of the relative value of the different sectors of the different companies. Let's put it very, very clear. You know, we are now reassessing what is the future income that may come from the markets. That may come from different sectors. But I do not think that we will see a significant larger drop in price markets as a whole. I think we're already discounting a huge recession. [00:06:05] Speaker 1: If the virus and its economic consequences continue for longer than a few more months, I mean, how bad could it get the stock markets? I guess, you know, how much further could they fall? 10%, 20%, 30% even? [00:06:18] Fernando Fernandes: They can fall steadily a lot more than they have. I mean, we will see, as I said, episodes of lack of confidence, episodes of significant volatility. At some point, even large drops in particular markets. Because some expectations about the resumption of economic activity may not be materialized or the expectations on future treatment of the COVID-19 do not materialize. And then we will see, we will see significant momentarily drops. But as a whole, I don't think, you know, when you think about it, so the total, what we're seeing essentially is total wealth in the world being estimated to have vanished by 30%. What you really mean, what you really think what it means that stock prices basically across the world have fallen 30% is that we're assuming the crisis will wipe out 30% of the wealth in the economy. And I think this is a very, very significant impact already. So I cannot think of this crisis wiping out more than 30%. It has never happened. So at some point we will, I think, in fact, I'm a little optimistic on the general, I would assume much more expectations of seeing large, larger improvements in prices, larger gains in the stock market that we're seeing than today's level than the country. As I said, steadily, not momentarily, we will see huge volatility. And again, this is what I said, this is, this is a market for courageous people. This is a market where investors that have nothing to fear will make a lot of money. Because, you know, with these huge swings in prices, money changes enhance very rapidly. And again, we economists and we analysts will have to start looking outside our normal spreadsheets. And I think this is important. You know, for the next three months, a stock price will not reflect, to our extent, the typical cash flow projections that we all made. And companies, because it will reflect our market perception or how the economy will look like, let's say, September, you know, how will people go back to work? When will they go back to work? Will we go back to business as usual, in general, and all these things will affect market valuations. Fernando, thanks very much. Fernando, thanks very much.