V-shape, W, L or something new? What the economic recovery could look like
As portfolio managers consider the post-pandemic recovery, the data tells a fascinating story of what the future may hold for investors. Izak Odendaal, Investment Strategist at Old Mutual Wealth, gave us his insights. ARTICLE BY MARK VAN DIJK - 20 NOVEMBER 2020 - READ TIME: 3 MIN
As some countries recover and others battle new waves of Covid infections, the opinions of what ‘letter shape’ an economic recovery could look like have widened significantly.
When represented on a graph, the line of the post-pandemic economic recovery could take on any number of shapes, says Izak Odendaal, Investment Strategist at Old Mutual Wealth.
‘You’ll have heard the debates around whether post-lockdown economic recoveries will be V-shaped, which means they’ll bounce back quickly; U-shaped, which drags out for much longer; W-shaped, which many people are worried about in Europe where a second wave of infections and another round of lockdowns could pull the economy back into recession; and lastly L-shaped, which is no recovery at all,’ he says.
With different parts of the world responding and recovering differently, or not at all, the answer seems increasingly to be an amalgamation of different shapes. ‘We're seeing evidence of all these letter shapes, and some commentators have spoken about combining them all into a single letter shape – the letter K,’ explains Odendaal.
‘The stuff we import has become cheaper and the stuff we export has become more expensive.’
How K-Shaped recoveries work
Like the letter K, K-shaped recoveries split in two opposing directions, acknowledging that some sectors, countries, regions, and even some companies will have a positive recovery (represented by the upward-pointing leg on the K) while others will continue to fall (represented by t corresponding downward-pointing leg).
‘The first and obvious example is how different countries have handled the pandemic,’ says Odendaal. ‘In economies that don’t have the virus under control, there are all kinds of restrictions in place and life cannot return to normal. Importantly, even if there aren’t official restrictions, consumers are voluntarily holding back.
‘Meanwhile, in countries where things are under control, consumer spending is growing at a rapid clip and there’s a much quicker economic bounceback.’
In some cases, however, K-shaped recoveries reflect a zero-sum game, like the sale of textiles, clothing and footwear in the UK: ‘Online sales are up by more than 20% since January 2020, while bricks-and-mortar store retail sales of the same products are down by nearly 20%,’ he says.
What this means for South Africa
One K-shaped graph shows the divergence between government spending and government revenue (or tax income). ‘Government spending – especially on healthcare – clearly had to increase as a result of the pandemic,’ says Odendaal. ‘At the same time tax revenue collapsed, because when the economy falls, tax revenue falls with it.’
Two factors complicate the issue in South Africa, he adds: one is that we came into the crisis with a large budget deficit; the other is that our government has to borrow at very high interest rates, due to our credit rating.
There’s a silver lining for South Africa, however, in the K-shaped divergence between the prices of commodities we import (e.g. oil, where the price fell sharply) and those of commodities we export (e.g. gold, palladium and iron ore, which have all increased by about 20%). ‘The stuff we buy has become cheaper and the stuff we sell has become more expensive,’ Odendaal says, which is working in favour of the country’s economic outlook despite the challenges.
What does a K-shaped recovery mean for investors?
There are questions about how those price gaps could close, says Odendaal, especially now that there are seemingly effective vaccines in the pipeline. However, the reality is that some could just keep on growing indefinitely. Some business models might be permanently altered by the pandemic, and the financial positions of some households might never catch up.
‘That’s something investors will have to think about very carefully,’ he says. ‘In each instance, we have to ask whether this is a short-term trend or will it persist? Has the world fundamentally changed? I think the answers will again differ from country to country, sector to sector, and company to company.’
One thing’s for certain, though. There are enough K-shaped comparisons to confirm that the Covid-19 pandemic is producing big winners and big losers. As Odendaal concludes: ‘There’s a lot of work and serious thinking to be done with regard to how you put together your investment portfolio.’