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BCG Covid-19 StrategicAndTacticalScenarios 14mar20
BCG Covid-19 StrategicAndTacticalScenarios 14mar20
scenarios for a
potential COVID-19
recession and recovery
BCG Center for Macroeconomics
1. Empirically,
• all flu shocks have historically been Vs
A very brief • major recessions have been deep Vs or Us,
recap of macro • L-shaped shocks require structural breaks (e.g. Japan in late 1980s)
shocks and In a recession framework, a flu pandemic represents an exogenous shock that
is particularly potent when an economy is already slowing and thus vulnerable,
recession risk
Illustrative
V U L
Return to pre-shock Growth resumes at lower Growth resumes at lower
level (trend)… level (trend) level (trend)…
Levels
…and growth rate (same …but at pre-shock …and at lower
slope) growth rate (slope) growth rate (slope)
Classic economic shock leading to Shock that breaks growth trend, Shock that perpetually breaks a
an intertemporal displacement of even as trend growth remains part of the growth model. A
demand, resume orig. output path same – typically financial structural impact that shifts the
recession or major policy error output path lower as well as
establishing a lower growth rate
5
Source: BCG Center for Macroeconomics analysis
Empirics I: Flu shocks have all been V-shape
Historical precedents interesting, not deterministic
2003 SARS 1957/58 H2N2 1968 H3N2 1918 Spanish Flu
(299 deaths in Hong Kong) (116k deaths in U.S.) (100k deaths in U.S.) (675k deaths in U.S.)
6
Source: U.S. Census, BEA, CDC, Census and Statistics Department (Hong Kong), BCG Center for Macroeconomics analysis
Empirics II: For U-shaped shocks need to turn to non-flu
examples
7
Source: NBER, BEA, BCG Center for Macroeconomics analysis
Empirics III: For L-shape need to turn to large structural
breaks
10
Source: BCG Center for Macroeconomics
COVID-19 crisis forces leaders to make two calls:
1 – the geometry of the shock (V-U-L growth paths), a critical strategic call
2 – the intensity of the shock (depth, speed, duration), a tactical call
V-U-L: Shock geometry vs. intensity Questions firms and investors need to ask
Illustrative
Intensity of shock (y-axis)
Intensity of shock (size)
V U L
• What is the shape of the fall and recovery?
Severe • How big is the loss relative to previous trend?
• Is the change permanent/structural?
• And: what determines the nature/geometry?
Trend growth Trend growth
unaffected downgraded
12
Source: BCG Center for Macroeconomics analysis
Geometry – be clear what the shapes really mean
Ask this question: what can present value of future output be under COVID-19?
V U L
Contained loss Significant lost value Significant and perpetually
growing lost value
Perpetually growing
No lost output Same perpetually lost output
lost output
Lost output
Lost output Lost output
V shape leaves de minimis impact U shape results in dramatically L shape results in even more and
on the present value of future more and perpetual loss of present ever growing loss in future output,
output value of future output potentially infinite loss of future
value
13
Source: BCG Center for Macroeconomics analysis
Intensity – be clear what GDP drawdowns can be
Ask this question: What can depth, speed, and length of COVID drawdown be?
U.S. recession and GDP drawdowns over the past 60 years – notated with drawdowns length (qtrs) and depth
1Q 1Q
-0.29% -0.03%
2Q 1Q 1Q
1Q
3Q -0.64% -0.42% -0.28%
-0.53% 2Q
-1.34% 1Q -1.37%
-1.07% 2Q
-2.18%
Recession
1Q
-2.63%
-0.74%
5Q
-3.14%
6Q
-3.98%
• The intensity drawdown (peak to trough) can very widely – 0.03bps (2011) to 4% (2008/9)
• The intensity duration (peak to trough) of shock can very widely – 1Q to many (6Q in 2008/09)
14
Source: NBER, BEA, BCG Center for Macroeconomics analysis
How to make strategic and tactical call: drivers
Shock geometry is a function
Virus
of the impact on growth of
Microeconomic
Severe
V U L efforts, and the reaction of
households and firms
15
Source: BCG Center for Macroeconomics analysis
Assessing shock geometry: Why V is likely, U plausible
but unlikely, and L possible but not plausible
Drivers of US potential growth What you have to believe for COVID-19 crisis to have…
over the last 10 years (%) …for V-shape …for U-shape …for L-shape
Labor input No change to labor The mortality rate is such that To permanently change the labor input
20 input growth the labor supply shifts down dimension of an economy's supply side, the
growth (one-off) virus' mortality would have to recur each year
to reduce labor supply growth (i.e. no vaccine,
and no conclusive mitigation, indefinitely)
Capital input No change to capital Investment is delayed and not To permanently change capital input growth on
40
growth stock growth caught up, shifting down the supply-side, the virus would have to impair the
2009-2019 Likely Plausible but not likely Possible in theory but less plausible
16
Source: CBO, BCG Center for Macroeconomics analysis
Assessing shock intensity: What you'd want to know
Insufficient testing and slowly unfolding mitigation efforts in U.S. make assessment challenging
Drivers of shock
intensity Drivers/Risk Impact on intensity Current risk profile (U.S.)
Contagion/Higher R0 rate Debated (perhaps 2 - 3.1)
• Even current profile of
Mortality/Higher than assumed death rate virus has the potential for Debated (varies by age: 0 – 18%)
Virus properties highest shock intensity
Virus resilience/Longer survival period Widely debated
(SARS-CoV-2) • Risks describe further
Weather/Risk of late spring/no seasonal eff. downside(s), e.g. Too early to say
mutation
Mutations/Risk of worse virus Unknown
19
Source: BCG Center for Macroeconomics analysis
Where recent shocks and recessions fit in this scheme
Illustrative
Last 3 US recession in terms of geometry vs. intensity Description
2001 recession 1991 recession
(-0.4%/1Q) (-1.4%/2Q)
Duration of
• The last three U.S. recession can
Real GDP
Drawdown drawdown (Qtrs) provide grounding for the dimension of
the intensity and form.
• 1991 was a V shape recession –
V U L 1Q 1.4% GDP drawdown over 2Q,
Intensity of shock
(~0%)
with a hint of U as for a long time
it look as if growth wouldn't
21
Source: BCG Center for Macroeconomics analysis
Scenario 2: What we fear… is a deep "V-shape"
Illustrative
Scenario description What you have to believe
What we think can be
Real GDP
avoided Duration of • If mitigation efforts are unsuccessful
Drawdown drawdown (Qtrs) and/or have to be maintained for a
sustained period of time the dip has the
potential to be much worse as
(~0%) V U L 1Q consumption continues to fall, aided by
2001
Intensity of shock
22
Source: BCG Center for Macroeconomics analysis
Scenario 3: U-shape is plausible but not likely – for this
COVID-19 would need to deliver a financial system crisis
Illustrative
Scenario description What you have to believe
What we think is possible,
but not plausible Duration of
• A "U-shape" downturn would require
Real GDP
Drawdown drawdown (Qtrs) damage to the potential of the
economy – this would require a
permanently lower level of capital,
(~0%) V U L 1Q labor or productivity
2001
• While this is possible a significant U
Intensity of shock
23
Source: BCG Center for Macroeconomics analysis
Scenario 4: L-shape we deem very unlikely – for that,
you'd have to believe in economy's structural break
Illustrative
Scenario description What you have to believe
We find this highly unlikely
Real GDP Duration of
drawdown (Qtrs)
Drawdown • We find an L shaped recession as
impossible. Why? Because it would
require sustained regular damage to
(~0%) V U L 1Q
2001 the growth in labor, capital or
Intensity of shock
productivity
V U L
pandemic), to capital (a decline in
(>3%) >4Q
willingness and ability to invest) or
2008
productivity (break in the capacity
Trend growth Trend growth
unaffected downgraded
to learn)
• Additionally a break in institutional
Geometry of shock (V-U-L) capacity could impair potential
growth
24
Source: BCG Center for Macroeconomics analysis
Recall that shocks are not automatically recessions,
even when a significant flu hits a vulnerable economy
Epidemic U.S. cyclical tightness1 (unemployment rate, %) U.S. cyclical narrative
8 Very long, tight expansion
Recessions
Start
(HK)
Peak
(US)
Vulnerable to exogenous
shocks, similar to today
Hong Kong flu 6
Hong Kong flu hits in 1968
(1968-69) Does not end cycle
4
US WW I effort
Recessions Recessions
Spanish flu intersects with end
10 Start Peak of WWI (1918)
(US) (US)
De-mobilization of war effort
Spanish flu primes economy for recession2
(1918-20) 5 Yet, recession does not hit
until 1920
0
1914 1915 1916 1917 1918 1919 1920 1921
1. We use US data for this analysis because the most granular historical economic data is available there 2. De-mobilization lead to rise in unemployment/recession in 1918 not shown here25
Source: NBER, Bureau of Economic Analysis, WHO, BCG Henderson Institute analysis
Still meaningful chance of avoiding a technical recession
Depending on timing, 6-month slump can be recession or narrow escape, 9mths is unambiguous
ILLUSTRATIVE
2020 Q1 Q2 Q3 Q4
Examples/scenarios
26
Source: BCG Center for Macroeconomics analysis
Though NBER could have different view ex-post on
COVID-19 recession (or not)…
2 quarters definition NBER recession definition
(rules-based) (committee/assessment based)
• Rule of "technical" recession is 2Q of • National Bureau of Economic Research
sequential negative real GDP growth (NBER) is official arbiter of U.S. recessions
• Advantages include standardized, strictly data • Considers a wide array of factors that are not
dependent, allows comparison across a variety tied down: "the Committee does not have a
of geographies fixed definition of economic activity. It
27
Source: NBER, BCG Center for Macroeconomics analysis
China's path indicative of what a strong response can deliver
China data re-based for weekdays excl. weekends relative to start of Chinese New Year
People and goods are starting to Inputs are being used as coal Confidence isn't broken as
move again consumption moves higher property transaction restart
• Knowledge of R0
Virus • Births
• Knowledge of mortality Impact on labor
properties • Profile (age of deaths)
• Vaccine development input growth
(SARS-CoV-2) • Deaths
• Cases/recoveries/deaths
• Social distancing
Mitigation
Business failures
29
Source: BCG Center for Macroeconomics analysis
Discussion in this document has been about the macro/growth
context within which firms operate
Expect idiosyncratic firm and sector-level impact, driven by
variations in geographic footprint, business models, and reaction
functions
Firm-level (and even industry-level) U and L shapes are likely even
4. in context of V-shaped macro path
As outlined, we have considerable confidence Even as V-shape plays out at macro level,
on geometry of shock (strategic call), less so on individual firms could still face U or L scenarios
intensity of shock (tactical call) (e.g. airlines, cruise lines, live entertainment
31
Source: BCG Center for Macroeconomics analysis
To illustrate, some companies flourish in downturns…
14% of companies improve growth and margin …and the performance gap
in downturns, while 44% decline in both… between them is substantial
Increasing sales growth
Revenue growth Change in
A (CAGR)2 EBIT margin2
8.8% +14pp
14% 14%
44% 28%
-4.7% -4.4pp
B
Falling sales growth
A B A B
1. Average across last four U.S. downturns since 1986; based on performance compared to three-year pre-downturn baseline for U.S. companies with at least $50M sales 2. Annualized revenue
32
growth during the downturn period 3. Compared to three-year average pre-downturn EBIT margin | Source: S&P Compustat and Capital IQ, BCG Henderson Institute
…and that holds across all industries
Falling
32% 34% 28%
B growth and 36%
EBIT margin 47% 45% 46% 45%
54% 53%
Avg:
44%
1. Average across last four U.S. downturns since 1986; based on performance compared to three-year pre-downturn baseline for U.S. companies with at least $50M sales 33
Note: Sectors based on GICS definitions | Source: S&P Compustat and Capital IQ, BCG Henderson Institute
COVID-19 has potential for microeconomic legacy
35
Source: BCG Center for Macroeconomics analysis
Recent BCG economics publications on COVID-19
36
Source: BCG Center for Macroeconomics
And recent COVID-19 publications with economics angle
Martin Reeves
Paul Swartz
Director
Senior Economist
swartz.paul@bcg.com
38
Source: BCG Center for Macroeconomics
bcg.com