The writer, a former member of the Bank of England’s monetary policy committee, is a distinguished fellow at Chatham House
Among the many unusual features of the pandemic-induced downturn is the disconnect between depressed real economies and buoyant financial markets. This is particularly evident in the US, where output fell 9.5 per cent in the second quarter while the S&P 500 index rose by a fifth. This may suggest a huge financial bubble is in the making, or at least a highly optimistic view of a Covid-19 vaccine and treatments. Another possibility is that markets have a better grasp of the economic dynamics of a post-pandemic world than most nervous consumers and governments.
Certainly, markets have been helped by central bank largesse. In March, major central banks reacted forcefully to the possibility of a serious credit crunch with lending guarantees and bond purchases. Such liquidity interventions soothe troubled markets, but they also raise asset prices — potentially into bubble territory. This partly explains the markets’ strength. But it may not be the whole story.
A closer look at market performance suggests they may be on to something more interesting. Compare the US’s broad-based S&P 500 equity index with the tech-focused Nasdaq 100. Since the start of the year, the Nasdaq has risen 24 per cent while the S&P is up just 5 per cent. In the S&P itself, it has been the dramatic rise of the so-called Faang companies — Facebook, Amazon, Apple, Netflix and Google/Alphabet — that offset lesser performances by the other 495 companies. This sharp difference reflects two forces.
First, the Covid-19 crisis has had vastly different effects on different sectors. Lockdown brought a sudden increase in demand for the technology services that enable home learning (with school closures); homeworking (especially by office workers); home entertainment (instead of cinemas and theatres); home shopping (instead of physical shops); and home deliveries of almost everything else, including food. The Faang companies benefited disproportionally from this surge in demand as their production is scalable. Much of it could also be delivered by employees who themselves worked from home. The rise in their share prices reflects this.
Meanwhile, other sectors suffered massively. In the UK, the overall drop in gross domestic product of 20 per cent in the second quarter was led by a fall of 87 per cent in the accommodation and food services sector, which was severely affected by government restrictions. About a quarter of the UK workforce, according to official figures, was also furloughed or temporarily off work without pay during lockdown. The fall in the share prices of hotels, restaurant franchises and airlines reflects such factors.
The second driver of rising markets is that they are forward looking while economic statistics reflect the past. For example, that UK GDP shrank during the second quarter is less interesting to a financial investor than the fact that during two months, May and June, GDP expanded by 2.4 per cent and 8.7 per cent respectively. In other words, output troughed in April but recovery began in May and accelerated in June as lockdown restrictions were eased.
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It is likely that rapid adaptations by companies and consumers to the pandemic-supercharged trends are already under way. In Britain, the share of retail sales (excluding fuel) made by ecommerce rose from around 7 per cent in 2010 to 20 per cent at the beginning of 2020; it has since jumped to over 30 per cent. One-third of those officially working from home meanwhile say that they would like to do that permanently, according to the Centre for Economics and Business Research, and many large companies have offered their staff this choice. Even in labour-intensive sectors like healthcare and government services there has been a replacement of face-to-face delivery with digital booking and screen-based consultations.
Still, while this may help some companies in certain sectors, it does not imply a smooth recovery for the whole economy. Rather, it augurs a period of disruption as new companies, new business models and new job openings emerge. If the pandemic has ignited a Schumpeterian process of creative destruction, that is likely to continue whether or not effective vaccines and treatments ever come. Governments should ease the pain of this disruption with supportive fiscal and monetary policies, but they should not try to slow it down. The hopeful market message is that one lasting consequence of Covid-19 may be the rejuvenation of productivity growth that eventually spreads far beyond tech.
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