More Like 1918 Than 2008 ?

20/03/2020

Forget the falling markets of 2008, the Covid-19 shock is more like the flu pandemic of 1918. Exploring the similarities between then and now provides clues as to how the current pandemic may develop and affect different sectors of the global economy, explains Aditya Khowala of Fidelity.

However bad this crisis is, it is not the Great Financial Crisis (GFC). The GFC was a balance sheet recession triggered by a collapsing housing sector and a dearth of confidence in banks. This time, the travel, tourism and retail sectors are the most vulnerable, but the overall time to recovery could be shorter if previous trends hold.

In my view, rather than looking back 12 years, we should explore the events of 102 years ago. This is because the Covid-19 crash is an event-based crisis that in some respects is comparable to the 1918-1919 pandemic flu. Then, the recession lasted only seven months, despite the second wave of infections in autumn 1918 being more deadly than the first. 

During the 1918-1919 pandemic, already reeling from a world war, 5 per cent of the global population died and one-third got infected. We are already in the second month of this event globally and our health systems are much better organised than they were in 1918, but it remains to be seen how the virus will progress and how soon it will be contained. 

Nonetheless, it is useful to consider the extent of past event-based crises versus structural and cyclical ones, especially as China’s new case data has improved every week since the start of March, and the country is close to normalising in several areas.

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As we saw first in China, then in Asia and then across the world, the most immediate impact from virus containment measures has been felt in the travel and tourism sector. Given the sector accounts for 10.4 per cent of the global economy and employs 10 per cent of the global workforce, the knock-on effects will be significant.

It takes an average of around 19.4 months for the sector to recover from epidemics, according to the World Travel and Tourism Council, longer even than the 11.5 months required to snap back from terrorist attacks.  Airlines, cruise liners, hotels, restaurants and associated sectors in their supply chains will all suffer in the coming weeks and months, and it will take them at least until next summer to normalise. 

While there was no internet in 1918, a variety of businesses were affected. Economic data from the time is scarce but according to a 2007 study of the 1918 pandemic  by the St Louis Fed, newspaper articles from Little Rock, Arkansas, show that merchants said business decreased by 40-70 per cent during the outbreak, while retail groceries fell by one-third. The only business in Little Rock that saw an increase in activity that year was the drug store.

Back in the present day, financials, especially banks, have taken a big hit and are trading well below tangible book value, with dividend yields much higher than US treasuries. However, I believe the US banking system is more resilient than in 2008, with much better risk controls and significantly more capital.

Industrials, meanwhile, had already started to recover from a slowdown and have seen this all before. With China starting to come back and inventories drawn down in the system, I expect industrials to recover faster than consumer sectors over the next six months. And with over 75 per cent of equities overall offering higher yields than US treasuries – a record high – the risk/reward ratios are looking more favourable over the medium term, as we weigh up the economic impact of the virus versus the magnitude of the monetary and fiscal response. 

While 2008 is still fresh in the minds of market participants, this shock will play out differently, with tourism, rather than banks, at the epicentre

Written by Colin Caulfield | Director

Colin is a Chartered Financial Planner & Pension Adviser Of the Year Read more >>

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