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Mar 2, 2020

Economic Perspective - Economic Growth and Equity Market Leadership

by Robert F. DeLucia,
CFA Consulting

Summary and Major Conclusions:

  • The outbreak of the coronavirus late last year has been a game changer for the world economy. As such, I have revised my forecasts for GDP in all the major economies, most notably for that of China, but also modestly for that of the US.
  • The impact on China is by far the greatest. The epidemic is acting as a freeze on commerce in China. Retail stores have closed, factories have shuttered, real estate transactions have plummeted, and transportation both into and out of China has been curtailed.
  • I have reduced US GDP growth in Q1 to an annual rate of 1.5%, down from 2.2% for all of 2019. Downward revisions to China’s GDP are far greater. First quarter GDP growth could decline by 50%, from 6% in 2019 to only 3%.
  • Assuming that the epidemic is contained during the spring months, world economic growth could rebound strongly during the second half of the year. Fourth quarter US GDP could grow at a 3.5% annual rate, while China’s GDP could expand at a temporarily above-trend pace of 7.5%.
  • In the US, second half GDP growth should benefit from the lagged effect of monetary stimulus, a resumption of production at Boeing, a restoration of depleted business inventories, and continued strength in consumer spending and housing.
  • Corporate debt issuance has increased at a rapid pace in recent years, pushing the debt-to-GDP ratio to an all-time high. However, a significant portion of borrowing has been opportunistic and motivated by a record-low cost of debt capital, with market yields declining to an all-time low of 2.52%.
  • Moreover, corporations have appropriately extended the duration of their debt to an average of eight years, the longest average maturity in 40 years. These longer maturities allow companies to lock in record-low borrowing costs for many years.
  • Credit quality in the corporate sector should remain benign until there is a sharp rise in interest rates, a decline in corporate earnings and cash flow, and a sharp pullback in bank lending.
  • Conditions for bond investors are far less favorable. High-grade corporate bonds are grossly overvalued: With current yields to maturity only slightly above the inflation rate, bond investors are virtually assured of a loss of principal in coming years.


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