Business in strict confidence

COVID-19: Economic Brief

Assessing implications for economies, sectors and markets

17 July 2020

Grant Colquhoun, Marie-Louise Deshaires and Roxane Osuna Business in strict confidence

Developments and implications summary – 17 July

Overview  The number of Covid-19 cases globally is rising by an average of over 200,000 per day, the fastest rate of increase since the pandemic began.  Between them, the United States, Brazil and India account for around 60 per cent of daily new coronavirus cases. Rising new infections point to drawn out recoveries and downside risks.

Sectors  United States retail sales in June were better-than-expected, but the upturn in infections is causing the consumer recovery to lose momentum.  Korean trade data suggest that the recovery in external demand gained a little momentum at the start of July. But with global demand unlikely to bounce back quickly, Asia’s export-dependent economies and their manufacturing sectors will continue to feel the strain.

Markets  Price-to-earnings (P/E) ratios for emerging markets have risen sharply for some key equity indices and are now at the upper end of their historical ranges. While they look high relative to their past levels we don’t think that this will necessarily prevent them from rising further.  The biggest risk to the outlook for stock markets in emerging and developed markets now is probably a renewed hit to economic activity from the recent resurgence of coronavirus cases.

Forecasts  The Chinese economy recovered strongly this quarter and is back to pre-crisis levels. More generally, after shrinking by 5.7 per cent quarter-on-quarter in the current quarter, we expect the global economy to rebound by 6.2 per cent in the third quarter.  Over forecasts this week are little changed overall. The global economy is projected to decline by 4.5 per cent this year and grow by 7.1 per cent in 2021.

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Latest new cases and containment policy developments

New cases per Trend in Latest virus containment policy developments million people* new cases Asia China 0.04 No new policy development. Improving / Korea 0.9 No new policy development. Less Japan 2.7 Tokyo raised its alert level to the highest “red” level after a spike in daily cases. restrictive

Singapore 50.1 No new policy development.

India 21.3 The northern Indian state of Bihar reimposed a new 15-day lockdown for all 125 million citizens. Europe

Germany 5.6 No new policy development.

France 16.6 France has announced that the wearing of face masks in enclosed public spaces will be compulsory.

Italy 2.9 No new policy development. Barcelona has stated that it may follow suit with restrictions in some of its districts after some regions in Catalunio Spain 29.0 implemented lockdowns. Magaluf, in Mallorca, closed two of its main streets due to failure to socially distance. Poland 8.2 No new policy development. Worsening / More On the 13 July, beauty salons, spas, tattoo parlours and nail bars re-opened. indoor gyms, swimming pools and United Kingdom 12.1 leisure centres are set to re-open on 25 July. The Government announced that it will be compulsory to wear a face restrictive covering in shops in England from Friday 24 July. Americas Restrictions are being tightened in Oregon and New Mexico, and California has ordered all bars to close statewide United States 184.6 and all restaurants, movie theatres and museums to halt indoor operations. Mexico 40.3 Mexico extended its US-border closure to non-essential traffic by another month, until 21 August.

Brazil 133.9 No new policy development. Sources: Capital Economics and various Note: *Change in confirmed cases per million people, seven day average.

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Aggregate measure of the stringency of containment policies in place

Stringency index of selected Asian countries, from 0=less Stringency index of selected European countries, from 0=less stringent to 100=most stringent, points stringent to 100=most stringent, points

China Korea Japan Singapore India Germany France Italy Spain 100 100

80 80

60 60

40 40

20 20

0 0 Jan-20 Feb-20 Mar-20 Apr-20 May-20 Jun-20 Jul-20 Jan-20 Feb-20 Mar-20 Apr-20 May-20 Jun-20 Jul-20

Stringency index of selected American countries, from 0=less Stringency index of selected European countries, from 0=less stringent to 100=most stringent, points stringent to 100=most stringent, points

United States Canada Mexico Brazil Poland United Kingdom Russia Sweden 100 100

80 80

60 60

40 40

20 20

0 0 Jan-20 Feb-20 Mar-20 Apr-20 May-20 Jun-20 Jul-20 Jan-20 Feb-20 Mar-20 Apr-20 May-20 Jun-20 Jul-20

Sources: Capital Economics and Oxford University.

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Rising numbers of new infections point to drawn out recoveries and downside risks

US, Brazil and India account for 60 per cent of new cases globally Daily reported change in confirmed cases of coronavirus, selected countries, seven day moving average, thousands The number of Covid-19 cases globally is rising by an average of over 200,000 per day, the fastest rate of increase since the pandemic USA Other developed markets began. Between them, the United States, Brazil and India account China Other large EM* for around 60 per cent of daily new infections. 100 Other emerging markets The resurgence in the outbreak in the United States after restrictions 80 *Brazil, Mexico, Russia, South were eased has shown no signs of slowing. Governors in some of Africa and India the most affected states like Texas have rejected any idea of 60 reimposing shutdowns, even as coronavirus continues spreading 40 rapidly. However, after seeing the result of premature openings, states such as California, Arizona and Florida appear to be moving 20 towards reinstating strict social distancing measures and requiring citizens to wear masks. The growing number of infections could 0 result in the economy undershooting our forecasts. 02-Feb 27-Feb 23-Mar 17-Apr 12-May 06-Jun 01-Jul

Increases in new cases in Brazil have stalled but, having relaxed its Daily reported change in confirmed cases of coronavirus, lockdown before containing the virus, the risk is that they accelerate selected countries, seven day moving average, thousands once more. The wide circulation of the virus is weighing on the economy, making a V-shaped economic recovery unlikely. Brazil Mexico Russia India South Africa

Economic recoveries will be drawn out in parts of Asia 40 India has yet to bring the virus under control. Given the likelihood of a renewed tightening in containment measures and the 30 substantial damage already caused during the lockdown, the road to normality will be long and difficult. 20

After gradually reopening their economies, cases are rising in 10 Indonesia and the Philippines as well. Looser restrictions led to an initial increase in activity but with social distancing set to continue 0 for much longer, recoveries will be more drawn out. These countries 02-Feb 25-Feb 19-Mar 11-Apr 04-May 27-May 19-Jun 12-Jul are also at greatest risk of renewed outbreaks, which could lead to lockdowns being re-imposed. Sources: Capital Economics and Refinitiv. Note: Case numbers subject to revision.

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Trackers: United States recovery loses pace; euro-zone powers on

Recovery trends uneven across developed markets Capital Economics regional Covid-19 Recovery Trackers, difference from January-6th February baseline, per cent Our global average Covid-19 Recovery Tracker maintained its upward trend in recent weeks as governments generally continued to ease DM Euro-zone Other DM EM Em. Asia Latam restrictions further. Emerging Europe is the only region where our 20 trackers have returned to pre-virus levels. This has been reflected in ME&A Em. Europe US solid rebounds in the hard data and sits well with our view that 0 central and eastern Europe will outperform most European and Activity further below -20 emerging market economies this year. pre-virus level In developed markets, the euro-zone leads the way with robust -40 rebounds particularly in France, Italy, and Spain. In contrast, the United States recovery has stalled. This is partly because of the -60 reimposition of restrictions in some states, but also due to an upturn in infections stoking fears about the virus. For now, we suspect the -80 recovery has just entered a slower phase, not gone into reverse 15-Feb 11-Mar 05-Apr 30-Apr 25-May 19-Jun 14-Jul

Capital Economics Euro-zone Covid-19 Recovery Trackers, United States daily infections, seven-days average, thousands difference from January-6th February baseline, per cent Germany France Italy Northeast Midwest South West 20 Spain Other Euro-zone 40 0 30 -20 -40 20 -60 10 -80

-100 0 15-Feb 11-Mar 05-Apr 30-Apr 25-May 19-Jun 14-Jul 15-Feb 11-Mar 05-Apr 30-Apr 25-May 19-Jun 14-Jul

Sources: Capital Economics, Google, Moovit and Apple.

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US infections resurgence a downside risk to our growth forecasts and the stock market

United States spending almost back to pre-pandemic level United States change in retail sales between February and June, per cent The better-than-expected 7.5 per cent month-on-month increase in United States retail sales in June suggests that the resurgence in 30 coronavirus infections in the South and the West hadn’t yet had an 20 impact on consumers. The high frequency data suggest that the recovery lost a lot of momentum in early July, but that’s not a 10 disaster because the rise in sales in June was big enough to eliminate 0 nearly all of the remaining shortfall relative to the pre-virus level. -10 That bigger gain in sales in June means that the decline in second- -20 quarter gross domestic product might be a bit smaller than the 30 -30 per cent annualised we currently have pencilled in. Mechanically, it should also mean that the third-quarter rebound could be bigger than the 22.5 per cent we are forecasting. But with the new wave of infections leading to renewed closures and restrictions, we still think the risks to that third-quarter forecast lies to the downside. Changes in S&P 500 earnings and sales per share by sector in Earnings season to corroborate varied performance of sectors H1 2020* vs. total return in H1 2020 The second quarter earnings season in the United States next week 90 Earnings per share Sales per share (RHS) will shed more light on how companies in different sectors of the 60 stock market have been affected by the spread of coronavirus. The 30 variety is huge, reflecting the contrasting effects of the virus on the 0 fortunes of firms operating in different spheres of the economy. -30 In general, the earnings of firms in the health care, information -60 technology and consumer staples sectors appear to have held up -90 *Includes estimates for Q2 2020 ~ -235 % best, while the those of firms in the energy, consumer discretionary -120 and financials sectors seem to have fared worst. Returns were generally also worst in sectors where earnings and sales appear to have been hit hardest. With that in mind, the biggest threat to the overall stock market now is probably a renewed hit to economic activity from the recent resurgence of coronavirus cases. Sources: Capital Economics, Refinitiv, ICE BofA ML, S&P and Bloomberg.

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Reassuring signs for European labour markets but this won’t spare euro-zone office rents

Reassuring despite largest fall in UK employment since 2011 United Kingdom employment, millions The smaller-than-expected fall in United Kingdom employment in May and evidence that the first wave of joblessness in the Weekly employment Headline employment (3m average) coronavirus crisis ended in June shows that the furlough scheme has been effective in preventing a big rise in unemployment. The 34 33500 126,000 fall in headline employment from December-February to March-May was the largest since September 2011, but was below the consensus forecast of 234,000. And the International Labour 33 33000 Organisation unemployment rate was unchanged at 3.9 per cent as 92,000 people left the workforce. 33 32500 Of course, there will be another wave of layoffs when the furlough scheme is wound down from August. We think that will cause the one per cent fall in employment so far to grow to five per cent and 32 32000 that the unemployment rate will rise to seven per cent in mid-2021. Jan-18 Jul-18 Jan-19 Jul-19 Jan-20

Better euro-zone jobs picture will not spare office rents Euro-zone office-based employment and office take-up Despite the apparent strength of the euro-zone labour market in early second quarter data and the office sector’s inherent resilience, Take-up (4 quarters average, million sqm, LHS) we still expect prime rents to fall this year on the back of the weak 3.0 Office-base jobs (adv. 2 quarters, % y/y, RHS) 6 economy and uncertainty surrounding the virus. The contraction CE we now expect in office-based jobs points to office take-up falling to 2.5 4 nearly 1.5 million square metres by the end of this year. This would f’casts represent a 35 per cent fall from its peak in the third quarter of 2019 2.0 2 on a four-quarter moving average basis, similar to the decline recorded during the global financial crisis. After 2021, the recovery 1.5 0 in activity will support office-based jobs and demand for space. 1.0 -2 Given this and despite the rosier labour market outlook, we still expect euro-zone prime office rents to fall by two per cent this year. 0.5 -4 But the stronger than expected performance in the labour market so 2010 2012 2014 2016 2018 2020 2022 far, along with our revised forecasts, suggest that the risks to our office rents forecasts for this year are now skewed to the upside. Sources: Capital Economics and Refinitiv.

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Signs of further recovery in parts of Asia with Chinese output back above pre-virus levels

Tentative signs of further recovery in Korea Korea exports, US billion dollars, working-day adjusted Korean trade data for the first ten days of this month suggest that the recovery in external demand gained a little momentum at the Full month (RHS) First ten days (LHS) start of July. In working-day and seasonally adjusted terms, export 65 22 values rose in the first ten days of July, after showing tentative signs 60 20 of a recovery in June. In working-day adjusted year-on-year terms, 18 exports grew -1.7 per cent, from -9.6 per cent June. 55 16 50 The recovery in the coming months is set to be slow – the worsening 14 45 second wave in the United States underscores that the drag on 12 global demand from coronavirus is far from over. Even if infections 40 10 remain under control elsewhere, scars from the pandemic to 35 household and corporate balance sheets means it will be some time 8 before demand in most trading partners is back to pre-crisis levels. 30 6 With global demand unlikely to recover quickly, Asia’s export- 2012 2013 2014 2015 2016 2017 2018 2019 2020 dependent economies will continue to feel the strain. China gross domestic product, Q4 2019=100, seasonally Strong end to Q2 pushes Chinese output above pre-virus levels adjusted

After a sharp contraction in the first quarter, the Chinese economy Industry and construction bounced back strongly in the second quarter, with the level of gross Services domestic product reaching a new high. Output rose 11.5 per cent 105 quarter-on-quarter, more than reversing the ten per cent drop in the Total gross domestic product first quarter and taking output back above the pre-virus high 100 reached in the final quarter of 2019. The monthly activity and spending figures show that growth was still accelerating heading 95 into the third quarter on the back of strong policy stimulus. 90

The recovery will inevitably slow down during the second half of 85 the year now that the initial boost from re-opening has passed. But with the labour market rapidly tightening, consumer confidence 80 returning, and fiscal stimulus still being ramped up, we think gross Jan-18 Jul-18 Jan-19 Jul-19 Jan-20 Jul-20 domestic product will return to its pre-virus trend by the end of the year, faster than in any other major economy. Sources: Capital Economics, CEIC, Wind and Korea Customs Service.

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Emerging market valuations at their highest since the Global Financial Crisis

Singapore’s economy contracted this quarter but is set to rebound Singapore gross domestic product, quarter-on-quarter and year-on-year Singapore’s economy contracted by the most on record in the second quarter of the year. According to the advanced estimate %q/q annualised %y/y released on Tuesday, Singapore gross domestic product shrank by 20 41.2 per cent in the second quarter on a quarter-on-quarter seasonally-adjusted annualised basis. In year-on-year terms output 10 fell by 12.6 per cent. 0 But with many restrictions to economic activity now lifted and -10 strong government support (equivalent to around twenty per cent of gross domestic product), output is set to rebound over the second -20 half of 2020. While we expect the economy to contract by six per -30 cent this year, it should rebound by ten per cent in 2021. Given that the advanced estimate for the second quarter was slightly stronger -40 than expected, the risks to our forecast are to the upside. 2014 2015 2016 2017 2018 2019 2020

High EM valuations unlikely to preclude further equity rally Forward price-to-earnings ratios of different equity indices While the valuations of emerging market equities look high relative to their past levels we don’t think that this will necessarily prevent 45 China (average of Shanghai and Shenzen) them from rising further, provided that the continued spread of the 40 MSCI World ex US coronavirus doesn’t derail the recovery of the global economy. 35 Price/earnings (P/E) ratios have risen sharply for some key equity MSCI EM indices since financial markets found a bottom in March, and are 30 MSCI US now at the upper end of their historical ranges, prompting 25 suggestions that they are now approaching bubble territory. 20 One reason that we wouldn’t put too much emphasis on high P/E 15 ratios in general is that earnings are distorted by the impact of the 10 pandemic, which has been very large but will probably also prove 5 short-lived. A more significant reason is that interest rates in nearly 0 all major economies look set to remain much lower than in the past for the foreseeable future. In our view, that means that the 2006 2008 2010 2012 2014 2016 2018 2020 sustainable valuations of risky assets globally are now higher. Sources: Capital Economics, CEIC, Refinitiv and Bloomberg.

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Gross domestic product forecasts, selected countries

Latest forecast for year-on-year change in gross domestic product in 2020, alongside pre-virus forecasts, per cent

Forecast as of 17 July Pre-crisis forecasts 10

5

0

-5

-10

-15

Source: Capital Economics. Note: * China Activity Proxy, not official measure of gross domestic product.

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Gross domestic product forecasts in detail, selected countries – 17th July

Real economic growth rate, quarter-on-quarter, per Forecasts, year-on-year, Revisions since pre-crisis, cent per cent percentage points

Q1 Q2 Q3 Q4 2020 2021 2020 2021

Asia China* -18.6 20.5 4.0 2.5 -1.0 11.0 -6.0 6.0

Korea -1.3 -4.0 2.0 1.7 -2.0 5.0 -4.5 2.5

Japan -0.6 -9.2 4.2 2.2 -6.0 4.5 -5.8 3.6

India 0.7 -16.7 9.0 6.8 -5.5 11.0 -11.2 4.5 Europe Germany -2.2 -6.2 3.0 1.8 -5 3 -5.2 2.4

France -5.3 -15.3 19.5 1.3 -7.5 7 -8.3 6

Italy -5.3 -16.2 16.5 2.0 -10 7.5 -10.2 7.3

Spain -5.2 -20.7 17.8 3.7 -12 8 -13.3 6.5

UK -2.2 -18.7 14.0 3.8 -11 9.5 -12 7.7 Americas US -1.3 -9.3 5.2 2.0 -4.6 4.5 -6.6 2.1

Mexico -1.2 -12.5 5.0 4.0 -10.5 6 -11 4

Brazil -1.5 -10.8 3.3 2.2 -8 3.5 -9.5 1.7

World -4.9 -5.7 6.2 2.8 -4.5 7.1 -7.3 3.9

Source: Capital Economics Note: * China Activity Proxy, not official measure of gross domestic product.

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Contact details

Grant Colquhoun Head of Consultancy [email protected]

Marie-Louise Deshaires Economist [email protected]

Roxane Osuna Economist [email protected]

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