Will COVID-19 be as bad as the GFC?

CommSec senior economist Ryan Felsman shares his thoughts on how this downturn compares to the GFC and the last recession. He also outlines the impact the pandemic may have on the economy, the sharemarket and house prices.

Economists love to call economic crises something. Various names have been ascribed to the current economic downturn, ranging from “The Global Virus Crisis”, “The Great Lockdown Recession” to simply “The COVID-19 recession”.

Under the Reserve Bank of Australia’s (RBA) current baseline scenario, the Aussie economy may contract by around 6% in the year to December 2020 – much more than the 1.4% contraction over the year to June 1991 – the last recession.

Australia’s economy was relatively unscathed during the Global Financial Crisis (GFC), posting just one quarter of contraction – the 0.5% decline in gross domestic product (GDP) in the December quarter, 2008.

So the economic downturn in 2020 will likely be the sharpest since at least World War II, but more likely the biggest contraction since the 1930s Great Depression. Still, thanks largely to the $102 billion JobKeeper wage subsidy program, the unemployment rate is forecast by the RBA to peak around 10% later in 2020, below the 11.2% jobless rate seen in December 1992.

Commonwealth Bank (CBA) Group economists have similar forecasts to the RBA. The CBA Group expects GDP to contract by 4.2% over the 2020 calendar year, before lifting by 1.8% in 2021. The unemployment rate could peak at around 9%.

An unprecedented amount of fiscal spending – $330 billion (or 16.2% of GDP) – has been outlaid by governments to support the economy. And the RBA has also bought over $50 billion in government bonds and provided $90 billion in funding to small- and medium-sized enterprises.

Interest rates will likely remain near zero for years, keeping borrowing costs low for households and businesses. But the economic stimulus will cost a lot of money. The government forecasts a $185 billion budget deficit (9.7% of GDP) in the current year – the highest (as a share of GDP) in 75 years.

The GFC and the pandemic crisis are very different in character. The major difference is that banks were the primary source of the problem in the GFC while this time it’s a health crisis.

US lawmakers have been quick to act, though, deploying $US3 trillion in stimulus, supported by swift action from the US Federal Reserve. The Fed has cut the fed funds rate to near zero and started purchasing corporate bonds and exchange traded funds in addition to buying $US120 billion worth of US Treasuries and mortgage-backed securities.

Outlook for the sharemarket

Looking at US sharemarkets, during the GFC it took nearly 18 months for the major indexes to fall by 50% highs to lows, reaching a nadir on 9 March, 2009. This time the S&P 500 index fell by 34% between 19 February and 23 March, 2020. Since that low point, the S&P 500 index has lifted by 50%. Global shares (MSCI World index) have even erased their losses for the year.

In Australia the benchmark Aussie S&P/ASX 200 index fell by 36.5% from the highs to the low, and although it has improved it is still around 14% off the February highs.

CommSec expects the ASX 200 index to lift another 5% by the end of 2020 to around 6,300 points. The current profit reporting season will be a good test for share prices, and we expect some digestive discomfort for investors after a period of economic stress and limited company guidance.

Valuations are clearly stretched with the ASX 200 trading at around 18 times 12-month forward prices. Consensus expectations are for at least a 20% slump in earnings – the biggest fall since the GFC.

More companies are expected to raise capital. And dividend payments may fall 40%. Around a third of companies have reduced, deferred, suspended or cancelled dividends since February. But still attractive dividend yields (around 3.8%) should result in solid total returns into year end.

Outlook for house prices

Australian house prices have eased since April – led lower by the Sydney and Melbourne markets – but elsewhere property markets have been pretty resilient.

Record low interest rates, government household income support, superannuation withdrawals and bank mortgage deferrals have cushioned the market from the virus shock so far. But higher unemployment, near zero inbound migration, potential removal of mortgage relief and rent holidays will likely push prices lower.

CBA Group economists estimate that national home prices will fall by around 10% from their April highs.

Ryan Felsman

Ryan Felsman is senior economist at CommSec. He has more than 20 years of financial markets experience.

This article was reviewed by Editorial Campaigns Manager Maria Bekiaris before it was published as part of our fact-checking process.

Main image source: taewafeel (Shutterstock)