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How are the US and China currently placed in tackling the deep global recession caused by the COVID-19 pandemic? Will these global superpowers ‘reboot’ and boost global share market returns?
The lockdown and isolation measures designed to control the spread of COVID-19 have had some destructive economic consequences. There’s no doubt that some 10 years out from the Global Financial Crisis (GFC) we are again confronting another deep recession.
Many countries, (Japan and parts of Europe, except Germany) entered the COVID-19 pandemic with large amounts of debt and, in many cases, negative interest rates and the pandemic’s economic cost may damage global growth prospects further.
Share markets will be watching closely to determine which countries can best re-open the economic system while limiting the re-acceleration of the infection rates.
The health crisis can be broken down into four phases:
We think that between Phase 1 and Phase 2 we are likely to see the bottom of the global economic cycle. However, the strength of the ensuing recovery will be largely determined by success in navigating Phases 3 and 4.
The global economic cycle is the fluctuation of the economy between periods of expansion (growth) and contraction (recession).
Factors such as gross domestic product (GDP), interest rates, total employment, and consumer spending, can help to determine the current stage of the economic cycle.
In comparison to China, the US has not been as successful at fighting COVID-19. While China is in Phase 2 and looking to build to Phase 3, the US is still in late Phase 1. The infection rate in the US is extremely high and the pace of flattening the infection curve is, at best, modest. However, the US is already re-opening its economy.
On the economic front, the US is also lagging China. However, relative to China at this stage of the infection spread, the US is re-opening relatively early. This does raise the risk of a re-acceleration in infections that could result in lockdowns being re-implemented in Phase 1. This risk is likely to be the main threat to the current solid share market rally.
The one key area where the US continues to lead China, and the world, is returns in its share market. This reflects the strength of the technology sector as the US continues to lead the technology race at this stage. That said, in certain sectors, like 5G, China has now assumed leadership.
US technology stocks such as Apple, Google, Microsoft, Facebook and Amazon, have remained strong through the share market correction, reinforcing the trend of significant outperformance over recent years.
The S&P 500 (the stock market index that measures the stock performance of 500 large companies listed on stock exchanges in the US) has bounced by around 33% since the late March 2020 low, while Chinese equities are up a still solid 13%.1
Tensions between the US and China have continued to escalate on the back of a swathe of issues, backdropped by the World Health Organisation’s agreement to run a COVID-19 inquiry. In addition, China’s move to introduce a controversial security law to tighten its control of Hong Kong has added to frictions and China is now pointing to the social unrest in the US in response.
US technology shares could be vulnerable to Chinese retaliation because of their high dependence on China as both a manufacturing hub and a large source of revenue. And with an election nearing, US President Trump may become even more aggressive towards China, posing even more risks for markets.
On the positive side, while US economic and health stabilisation lags China’s, technology stocks have continued to outperform to date. If the recovery can build through Phases 3 and 4, as expected through the rest of 2020, there could be a broader recovery that sees good share market investment opportunities extend outside of the technology sector.
However, while we may be reaching the bottom of the economic cycle and gaining confidence for recovery in 2021, the threat from a large second wave spike in infections is significant. The rising tensions between the US and China may also pose a threat to markets that could even see even technology stocks trading lower.
As always, you should continue to seek quality advice about your own personal financial goals before making shifts in your investment strategy.
Chief Investment Officer
Important information: This document is issued by IOOF Investment Services Ltd (IISL) ABN 80 007 350 405, AFSL 230703. IISL is a company within the IOOF Group which consists of IOOF Holdings Ltd ABN 49 100 103 722 and its related bodies corporate. This document contains general advice only and does not take into account your taxation and financial circumstances, needs and objectives. Before making any investment decisions, you should assess your own circumstances or seek advice from a financial adviser. Before you acquire a financial product, you should obtain and consider the Product Disclosure Statement available from us at www.ioof.com.au, by calling 1800 002 217 or from your financial adviser. The information in this document is current as at 11 June 2020. While this information is believed to be accurate and reliable at the time of publication, to the extent permitted by law, no liability is accepted for any loss or damage as a result of reliance upon it. Further, information in this article should not be viewed as a medical opinion or relied upon as such. Neither IISL nor any company in the IOOF Group guarantees the performance of any fund or the return of an investor’s capital. Examples are for illustrative purposes only and are subject to the assumptions and qualifications disclosed. Past performance is not a reliable indicator of future performance.