The macroeconomic backdrop of Covid-19 – and the role of tech
Knight Frank’s Victoria Ormond, CFA, Partner, Capital Markets Research, zooms out on the global macro-economic backdrop of Covid-19. Here’s how the landscape has shifted over the past few months and where it might be heading.
6 minutes to read
At the time of writing, we are now at over 60 million recorded cases of Covid-19 globally*. There have been large increases in testing, advances in therapeutics and several vaccines have now reached late stage trials, but it has become clear that coronavirus has not yet gone away.
Two of the insights that we are tracking with Active Capital are lockdowns and the severity of these around the world. As the northern hemisphere moves towards winter, we are seeing an increase in lockdowns, although so far, generally not as restrictive as in the initial weeks and months of Covid-19.
In addition to saving lives and protecting health services, through reducing transmission, priority has also been increasingly placed on keeping children in schools, returning to workplaces, and having local lockdowns where necessary and possible. This follows warmer months, where many countries relaxed restrictions and saw a closer return to normality. We are getting to a stage where, while we can’t say there will not be further lockdowns or disruptions in the future, we are getting the sense that there is more of a strategy in place as we understand more about the virus.
In terms of the macro-economy, some things are improving and we have particularly seen this in the equity markets with the announcement of promising early results from late stage trials from some vaccine providers.
However, markets are not yet back to normal. If we look at the Baltic Dry, which is a leading indicator of the demand for raw materials, we can see that it saw a significant decline during the midst of the first months of the pandemic. We then saw a significant upswing in pricing, however, some of this was related to shipping congestion, which decreased the number of ships able to carry raw materials for manufacturing, as well as an acceleration of retirement of ships. This reduced supply and pushed up pricing.
As at mid-November 2020, most of the gains of the Baltic Dry have been eroded (-43% reduction from the peak in July 2020), leaving the index just +2% above the start of the year. For now, the index remains broadly at pre-pandemic levels, which suggests that global manufacturing could have largely recovered from the initial shock of Covid-19.
We could see some near term further declines in the Baltic Dry, to the extent that we see a temporary increase in manufacturing disruption over the winter months, but this is unlikely to be as severe as in the initial wave of Covid-19.
There has also been continued equity market volatility reflected in the VIX (the Volatility Index), also known as the ‘investor fear gauge’. At the start of the pandemic, the VIX was at heights not seen since the Global Financial Crisis and while it has now reduced, the index remains above the long-term average; there continues to be heightened volatility.
Several equity indices, including the South Korean KOSPI, US S&P 500 or Japanese Nikkei 225 have now recovered their year-to-date losses and are at levels above those seen in January 2020. For the KOSPI and Nikkei, this is largely a broad scale recovery, reflected by these countries having seen relatively limited lockdown restrictions compared to other locations. According to Google’s workplace mobility tracker, workers are located in their usual place of work in these countries, at similar levels to those seen back in January or February 2020, before the pandemic took hold.
For the US equity markets, there is more divergence in performance. For example, the S&P 500 Banks Industry Group Index remains circa -25% down on the start of the year, with the overall S&P 500 year-to-date gains being largely driven by the tech sector.
To put this into context, if you look at the Amazon share price, it is up +70% year-to-date. Likewise, if you look at Microsoft, it is still up +35% year-to-date and it is companies like these which are helping lift the US indexes, in addition to the losses in other sectors reducing on news of progress with vaccines.
At the peak of the technology gains, at the start of September 2020, Amazon was up over +90%, Apple was up over +80% and Microsoft was up over +47%, making it even more clear to see the impact that tech has been having on the equity market. This illustrates that as we are looking to equity markets to determine recovery and sentiment, it is important to look at the sectors within the indexes as well.
In the face of considerable volatility, as well as large amounts of government and central bank support, we have seen 10-year government bond yields around the world remain significantly below where they were at the start of the year and we expect they could remain low for some time. For example, in Germany, the 10-year Bund yield is -0.57% versus -0.19% at the start of 2020.
We have seen 10-year US Treasury yields reduce by more than half, currently 0.87%, compared to 1.92% at the start of 2020 and similarly, in the UK, the 10-year Gilt yield is now 0.33% compared to 0.74% in January 2020. For real estate, this means the ‘risk free rate’ component of yields is likely to remain reduced for some time, even if the risk premium elevates or long-term growth declines for certain, less well-located, less core assets.
Geopolitics also continues to drive markets, albeit it is having a relatively muted response compared to the pandemic. Taking Brexit as an example, the near-term economic dislocation of Covid-19 has been magnitudes larger than the range of forecast economic growth fallout of the worst case Brexit scenario for the UK.
The liquid, transparent, safe-haven properties of the UK has largely dominated over considerations of geopolitical uncertainty over the last two quarters, with the UK being the number one country worldwide for cross-border real estate capital flows in both Q2 and Q3 20201.
Amid the predicted results of the US election and as betting odds regarding the likelihood of a trade deal between the United Kingdom and the European Union have increased to more than 80%, we have seen sterling appreciate against the dollar to highs of 1.33, a recovery from 1.14 seen in March 2020, but still below the 1.40-1.46 range we saw in the first half of 2016.
Nevertheless, this represents a currency gain compared to the lows of 1.23-1.25 we saw in the second half of 2016. This means that dollar-denominated or dollar-pegged investors who invested into the UK in the latter half of 2016, could be looking to see a currency gain as they approach a five year hold in their assets in the coming year.
Bringing this all together, we are not yet through the pandemic and many countries are approaching winter, where we could see further disruption. However, even as cases of Covid-19 continue to escalate, we are seeing the development of therapeutics and progress in vaccine trials, as well as improving strategies to manage the health implications of coronavirus, even if we aren’t there yet.
Given we are in a health-led economic dislocation, it is by fixing or managing the health impacts that we will see a structural recovery in economic markets. Regardless, in an environment of volatility and low bond yields, the case for the right sort of income producing real estate remains.
1Based on provisional data. Source RCA, Knight Frank
*These insights were first explored on September 25th 2020 in the webinar “Commercial Conversations: State of the nation - what we know and what we expect” and updated on November 18th 2020. All data cited in this article was accurate at the time. Watch the full discussion now.